Nothing But Net

Comments

Transcription

Nothing But Net
North America Equity Research
02 January 2008
Nothing But Net
2008 Internet Investment Guide
2007 saw Internet companies outperform the broader stock market,
as the HHH rose ~14%, vs. a ~5% rise in the S&P 500. We believe
some of the factors that drove F’07 outperformance will persist into
F’08, and thus expect the sector to outperform the broader market.
• Expect 34% EPS Growth, vs. 8% for the S&P 500. We expect
revenue growth to decelerate to 21.2% in F’08, from 25.6% in
F’07. We are projecting 34% earnings growth for our coverage
universe, compared to 8% for the S&P 500.
• Expect Blended CPM Pricing Growth Rate to Accelerate. We
think blended CPM pricing bottomed out in F’07. We expect
tighter offline inventory and better monetization techniques will
lead to a re-acceleration of growth in F’08.
• We Project Global Search Revenue to Hit $60B by 2011. We
are raising our F’08 global search revenue estimate to $30.5B,
from $26.2B, driven by strong volume trends, better-than-expected
monetization, and continued robust growth in Continental Europe.
We expect the global search market to reach $60B by 2011,
growing at a 28% CAGR over the next four years.
Internet
Imran Khan
AC
(1-212) 622-6693
[email protected]
Bridget Weishaar
(1-212) 622-5032
[email protected]
Lev Polinsky, CFA
(1-212) 622-8343
[email protected]
Joseph Boushelle, CFA
(1-212) 622-8523
[email protected]
China Internet
Dick WeiAC
(852) 2800 8535
[email protected]
• Global Consumer Growth Should Benefit Internet Companies.
World GDP growth has outpaced US growth in recent years, and a
projected 3-year CAGR of 6.5% for emerging economies means
hundreds of millions of new consumers. We think large Internet
companies’ global reach means they’ll benefit from this rising tide.
Please see our notes changing
ratings for Priceline, and our note
changing estimates for the
remainder of our coverage
released simultaneously.
• M&A Market Likely to Remain Healthy. The five biggest
companies in our universe generated $8.8B in FCF in F’07, a
number we project will grow to $12.5B in F’08. While some of
that cash should continue to fund share repurchases, we think a
significant portion of the incremental cash flow is likely to lead to
continued M&A in the sector.
All data and valuation in this
report priced as of 26 Dec 2007.
• Top Picks. The above trends translate into our top Overweight
ideas going into the new year: GOOG, YHOO, EXPE, OMTR,
SFLY and MNST.
www.morganmarkets.com
J.P. Morgan Securities Inc.
See page 309 for analyst certification and important disclosures, including investment banking relationships.
JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision. Customers of JPMorgan in the United States can receive independent, third-party research on the company
or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at
www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table of Contents
Key Investment Themes ..........................................................5
Dot.Khan’s Top Ten for 2008 .................................................13
U.S. Sector Outlooks..............................................................15
China Outlook .........................................................................99
Amazon.com, Neutral ($92.85) ............................................121
Blue Nile, Neutral ($74.16) ...................................................129
CNET Networks, Neutral ($8.90) ..........................................136
eBay, Overweight ($34.49) ...................................................144
Expedia, Overweight ($32.56)..............................................154
Google, Overweight ($710.84) .............................................161
HouseValues, Underweight ($2.94) .....................................169
InfoSpace, Neutral ($18.96)..................................................177
InnerWorkings, Neutral ($18.40)..........................................183
Liberty Interactive, Neutral ($19.79) ....................................190
Mercadolibre, Overweight ($72.85) .....................................199
Monster Worldwide, Overweight ($33.91)...........................208
Move, Inc., Neutral ($2.70) ...................................................215
Omniture, Overweight ($34.95)............................................222
Priceline, Overweight ($118.23)...........................................229
Shutterfly, Overweight ($27.38) ...........................................239
ValueClick, Overweight ($23.39)..........................................247
Yahoo!, Overweight ($23.96) ...............................................255
Baidu, Overweight ($399.67)................................................267
China Finance Online, Overweight ($23.75) .......................272
NetEase, Neutral ($19.33).....................................................276
Ninetowns, Underweight ($3.45) .........................................281
Shanda, Overweight ($34.39)...............................................285
Sina, Neutral ($45.50) ...........................................................290
Sohu, Overweight ($56.58)...................................................294
The9, Overweight ($23.50) ...................................................299
The authors acknowledge the contribution of Deval Delivala and Rachna Srivastava
of J.P. Morgan Services India Private Ltd., Mumbai, and John Ventimiglia of J.P.
Morgan Securities Inc. to this report.
2
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 1: JPMorgan Internet Technology Universe
$ in millions, except per share data
JP Morgan Internet Technology Universe
Ticker
Rating
Price
Mkt Cap
12/26 12/26
Ent .Val.
12/26
2007E
EPS
2008E
2009E
2007E
Cal PE
2008E
LT EPS
2009E Grth (%)
2007E
PEG
2008E
2009E
EBITDA ($M)
2007E
2008E
2009E
Ent. Val/EBITDA
2007E 2008E
2009E
2007E
Rev ($M)
2008E
2009E
Search/Advertising
CNET
CNET
N
Google
GOOG
OW
8.90
1,350
1,364
NM
0.14
0.22
NM
NM
40.4
15
NM
NM
2.7
82
100
118
16.7
13.7
11.6
411
451
494
710.84
225,035
211,948
15.42
20.92
26.33
46.1
34.0
27.0
35
1.3
1.0
0.8
6,958
9,917
12,647
30.5
21.4
16.8
11,719
16,957
22,332
Infospace
INSP
N
18.96
629
54
(1.49)
(0.88)
0.11
NM
NM
167.0
5
NM
NM
33.4
(9)
17
18
(5.8)
3.2
3.0
240
139
141
ValueClick
Yahoo*
VCLK
YHOO
OW
OW
23.39
23.96
2,343
33,426
2,092
25,615
0.71
0.43
0.84
0.49
1.01
0.58
33.0
55.9
27.7
49.4
23.1
41.0
20
25
1.6
2.2
1.4
2.0
1.2
1.6
164
1,906
190
2,248
220
2,533
12.8
13.4
11.0
11.4
9.5
10.1
639
5,095
735
5,895
859
6,433
45.0
37.0
59.7
1.7
1.4
7.9
18.3
12.1
10.2
Group Average
Leading e-Commerce brands
Amazon
AMZN
N
92.85
39,461
39,294
1.10
1.51
1.87
84.5
61.6
49.7
20
4.2
3.1
2.5
1,093
1,474
2,178
35.9
26.7
18.0
14,488
17,938
21,269
Blue Nile
NILE
N
74.16
1,254
1,180
1.03
1.23
1.50
71.9
60.4
49.5
20
3.6
3.0
2.5
30
36
44
38.8
32.6
26.9
322
388
454
Dice
DHX
R
8.14
505
587
eBay
EBAY
OW
34.49
46,727
42,283
1.48
1.70
1.98
23.3
20.3
17.4
25
0.9
0.8
0.7
2,863
3,337
3,754
14.8
12.7
11.3
7,685
9,007
10,506
Expedia
EXPE
OW
32.56
10,183
10,326
1.23
1.39
1.58
26.5
23.4
20.6
10
2.6
2.3
2.1
725
808
887
14.3
12.8
11.6
2,643
3,006
3,318
InnerWorkings
INWK
N
18.34
921
852
0.32
0.52
0.73
57.3
35.1
25.1
20
2.9
1.8
1.3
27
46
65
31.8
18.6
13.1
288
472
641
InterActive Corp
IACI
N
27.56
8,410
7,421
1.55
1.81
NA
17.8
15.2
NA
10
1.8
1.5
NA
867
958
NA
8.6
7.7
NA
6,352
6,897
NA
Liberty Interactive
LINTA
N
19.79
12,428
16,810
0.73
0.80
0.89
27.1
24.8
22.2
10
2.7
2.5
2.2
1,707
1,766
1,871
9.8
9.5
9.0
7,721
8,094
8,583
Mercadolibre
MELI
OW
72.85
3,227
3,164
0.21
0.58
0.86
354.1
126.2
84.6
30
11.8
4.2
2.8
24
43
68
132.2
73.7
46.3
84
134
195
Monster.com
MNST
OW
33.91
4,434
3,807
1.42
1.90
2.27
23.9
17.8
14.9
20
1.2
0.9
0.7
301
441
514
12.7
8.6
7.4
1,350
1,519
1,727
Orbitz Worldwide
OWW
R
9.43
784
1,320
Priceline.com
Shutterfly
PCLN
SFLY
OW
OW
118.23
27.38
5,430
671
4,930
576
3.96
0.38
4.87
0.53
6.08
0.75
29.8
71.6
24.3
51.3
19.4
36.3
15
20
2.0
3.6
1.6
2.6
1.3
1.8
161
32
296
45
408
61
30.5
18.1
16.6
12.9
12.1
9.4
1,402
183
1,710
251
2,026
328
63.6
38.1
30.7
3.1
2.1
1.7
28.2
19.1
14.8
NM
NM
88.6
191.8
56.1
40.3
NM
NM
3.5
NM
2.2
NM
8.1
2.2
5.6
1.0
4.8
0.9
294
60
320
49
349
54
NM
140.2
48.2
NM
3.5
2.2
5.1
3.3
2.8
Group Average
Online Services
Move.com
HouseValues
MOVE
SOLD
N
UW
2.70
2.94
419
72
233
7
(0.05)
(0.09)
0.03
0.02
0.05
0.07
Group Average
25
10
29
3
42
7
49
8
Enabling Platforms
Akamai^
AKAM
NR
36.80
6,590
5,859
1.29
1.66
2.01
28.6
22.2
18.3
25
1.1
0.9
0.7
275
368
469
21.3
15.9
12.5
628
805
994
Omniture
OMTR
OW
34.95
2,248
2,270
0.20
0.39
0.70
NA
NM
49.8
35
NA
NM
1.4
22
37
71
101.1
60.8
32.0
141
213
309
Salesforce.com^
CRM
NR
63.87
7,682
7,176
0.13
0.32
0.65
NA
199.4
98.9
40
NM
5.0
2.5
38
77
NA
189.4
92.7
NA
741
1,030
1,372
Visual Sciences
Websense^
VSCN
WBSN
NR
NR
19.31
17.16
369
777
394
496
0.59
0.90
0.75
1.13
0.74
1.35
32.9
19.1
25.6
15.1
26.1
12.8
20
15
1.6
1.3
1.3
1.0
1.3
0.9
15
53
21
47
NA
85
26.2
9.4
19.1
10.5
NA
NA
82
226
90
309
NA
338
Group Average
26.9
65.6
41.2
1.4
2.0
1.4
69.5
39.8
22.2
Average
59.0
55.7
42.8
2.7
2.1
3.2
33.6
21.7
14.0
Source: Company reports and JPMorgan estimates for JPMorgan rated companies. First Call consensus for non-covered companies. Note: Yahoo! EV assumes Yahoo! Japan is worth $26.9B. EBITDA – Operating Income + D&A +/- extraordinary charges
Data in this table and this report is priced as of December 26, 2007 close
JPMorgan is currently subject to a research blackout period for Dice Holdings, Inc and Orbitz Worldwide, Inc. Company write-ups are omitted here in compliance with NYSE and NASD provisions relating to lock-up agreements.
3
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 1: JPMorgan Estimates vs. Consensus Estimates
$ in millions, except per share data
Company
Amazon.Com Inc
CNET Networks Inc
eBay Inc
Expedia Inc
Google Inc
IAC/Interactivecorp
Infospace Inc
Innerworkings Inc
Liberty Media Interactive
Mercadolibre Inc
Monster Worldwide Inc
Move Inc
Blue Nile Inc
Omniture Inc
Priceline.Com Inc
Shutterfly Inc
HouseValues Inc
Valueclick Inc
Yahoo Inc
Ticker
AMZN
CNET
EBAY
EXPE
GOOG
IACI
INSP
INWK
LINTA
MELI
MNST
MOVE
NILE
OMTR
PCLN
SFLY
SOLD
VCLK
YHOO
Source: Company filings, First Call, and JPMorgan estimates
4
FC 08
1.62
0.14
1.66
1.46
20.65
1.81
-0.29
0.52
0.79
0.53
1.83
0.04
1.32
0.41
4.78
0.57
-0.07
0.82
0.55
JPM 08
1.51
0.14
1.70
1.39
20.92
1.81
-0.88
0.52
0.80
0.58
1.90
0.03
1.23
0.39
4.87
0.53
0.02
0.84
0.49
EPS
FC 09
2.41
0.20
1.94
1.74
25.89
2.06
-0.42
0.72
1.02
0.83
2.22
0.17
1.67
0.69
5.79
0.90
N/A
1.06
0.72
JPM 09
1.87
0.22
1.98
1.58
26.33
0.11
0.73
0.89
0.86
2.27
0.05
1.50
0.70
6.08
0.75
0.07
1.01
0.58
FC 08
18,256
450
9,031
3,008
16,547
6,862
137
468
8,156
131
1,561
318
394
220
1,690
252
46
741
5,954
Revenue
JPM 08
FC 09
17,938
22,373
451
487
9,007
10,603
3,006
3,371
16,957
21,306
6,897
7,206
139
144
472
625
8,094
8,727
134
186
1,519
1,815
320
374
388
470
213
327
1,710
1,870
251
326
49
#N/A
735
869
5,895
6,833
JPM 09
21,269
494
10,506
3,318
22,332
141
641
8,583
195
1,727
349
454
309
2,026
328
54
859
6,433
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Key Investment Themes
We Expect CPMs to Rise in 2008
While we think CPM growth was relatively muted in 2007, we expect 2008 will see
it accelerate, driven by several factors, including easier comps, better inventory sellthrough, behavioral and geographic targeting, and ad exchanges.
Tighter Offline Inventory
Broadcast network total day ratings were ~8% lower in 2007, and we expect
inventory is likely to continue shrinking further in 2008. Additionally, the reduced
supply will face higher demand, as we believe as much as 6% of spot TV ads in 2008
may be taken up by political ads. We expect the inventory tightness will have a
spillover effect online, as advertisers continue to shift a greater percentage of their
spend away from traditional media.
The Rise of Ad Networks
More than 80% of online inventory currently sells for less than a $1 CPM. As such,
we think ad networks present a significant opportunity for publishers to increase
yield, and, given the low base, the CPM enhancement from using ad networks will
not have to be very large, in absolute terms, to move the needle.
Inventory Aggregation
Many companies are aggregating traffic through partnerships and acquisitions. We
think aggregation is likely to lead to a certain degree of pricing power for the
aggregators. More importantly, we expect advertisers to be more willing to buy from
aggregators that offer them sufficient scale.
Easier Comps
2007 saw pressure on graphical ad CPMs, driven primarily by increases in nonpremium inventory, from sites such as MySpace and Facebook. We think the 2007
softness in the market is likely to set a lower base for 2008.
Free Cash Flow Likely to Drive M&A Activity
Large Internet companies are generating a significant amount of cash flow: looking
at the five largest Internet-only companies in our coverage universe, we estimate they
generated nearly $8.8B in FCF in F’07, and are poised to produce $12.5B FCF in
F’08.
Table 2: Free Cash Flow Generation at 5 Large Internet Companies
$ in millions
GOOG
YHOO
AMZN
EBAY
EXPE
Top 5 Total
$
$
$
$
$
$
2007
3,490
1,307
1,351
2,067
566
8,781
$
$
$
$
$
$
2008
5,675
1,643
1,705
2,612
860
12,494
Source: Company reports, JPMorgan estimates
5
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
While we believe some of these companies will use part of their income stream on
share repurchases, we expect that a significant part will continue to spur increased
M&A activity in the sector.
Table 3: Uses of Free Cash Flow at 5 Large Internet Companies, TTM
$ in million, 4Q’06 – 3Q’07
TTM FCF ($M)
GOOG
YHOO
AMZN
EBAY
EXPE
Top 5 Total
2,902
1,300
801
2,052
777
7,831
Cash Acquisitions/FCF
33.4%
33.6%
6.1%
15.5%
8.0%
23.4%
Buyback/FCF
0.0%
104.9%
31.0%
105.8%
179.8%
66.1%
Source: Company reports, JPMorgan Estimates
Note: Table does not include acquisitions made with stock, such as Google’s YouTube acquisition
In particular, we believe large companies will continue to seek out investments in
social media, where sites often grow virally and the large-caps appear satisfied, for
the most part, to let the public pick the winners out of a crowded field before making
acquisitions.
In the ad network and ad exchange space, we expect the need for scale to lead to
continued consolidation and M&A activity, although perhaps not at the scale we
have witnessed in F’07, most sizably with the DoubleClick and aQuantive
transactions.
We expect continued M&A to be motivated by one or more of these key factors:
•
Traffic. Developing high-traffic sites is difficult, and larger companies are often
willing to pay for sites that have proven an ability to generate traffic.
•
Technology. Companies that develop a technology that is difficult or
uneconomical to replicate are often targets for acquisitions; such companies may
also generate traffic, but the technology is a motivator for the buyer.
•
Transactional. Companies with a proven track record of revenue and sales
generation make attractive targets, as well; a recent example of a transactionalfocused acquisition is the 2007 purchase of Mezimedia by ValueClick.
Additionally, we continue to believe that there are synergies to be captured by a
strategic partnership among large-cap Internet companies, due to (1) increased scale,
(2) strengthened global footprint, (3) broadened user insights and (4) improved
operational efficiencies. We believe continuing share gains and product introductions
by Google may compel other large-cap Internet companies to explore strategic
alliances.
6
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 4: Selected M&A Activity in the Internet Space, 2007 (Please see Appendix of this section for full list)
Ticker
AMZN
AMZN
CNET
CNET
EBAY
EBAY
EBAY
EBAY
EBAY
EBAY
EXPE
EXPE
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
IACI
IACI
IACI
IACI
IACI
IACI
IACI
IACI
IACI
INSP
LINTA
MELI
MELI
MNST
MSFT
MSFT
MSFT
MSFT
MSFT
OMTR
OMTR
OMTR
OMTR
PCLN
SFLY
TFSM
VCLK
VCLK
YHOO
YHOO
YHOO
YHOO
YHOO
YHOO
Date
5/14/2007
5/23/2007
10/25/2007
11/5/2007
1/10/2007
2/27/2007
5/3/2007
5/30/2007
10/4/2007
12/20/2007
2/28/2007
5/23/2007
10/31/2006
1/4/2007
3/16/2007
4/13/2007
4/17/2007
4/20/2007
5/29/2007
5/31/2007
6/1/2007
6/6/2007
6/20/2007
7/2/2007
7/9/2007
7/19/2007
9/28/2007
10/9/2007
12/18/2007
12/20/2006
2/27/2007
2/27/2007
3/1/2007
3/19/2007
4/19/2007
5/17/2007
5/24/2007
7/2/2007
9/17/2007
5/11/2007
10/1/2001
11/13/2005
1/17/2007
5/18/2007
8/30/2007
10/3/2007
10/7/2007
10/24/2007
1/18/2007
2/14/2007
9/7/2007
10/25/2007
11/8/2007
6/27/2007
5/17/2007
12/4/2006
7/16/2007
1/9/2007
4/30/2007
6/21/2007
9/4/2007
9/14/2007
9/17/2007
Target
www.Dpreview.Com
Brilliance Audio Inc
Webshots
Findarticles.Com
Stubhub
Beijing Union Mobile Pay Ltd
Gittigidiyor.Com
Stumbleupon Inc
Via-Online Gmbh
Tom Online Inc
Smarter Travel Media Llc
Independent Traveler Inc
Jotspot Inc
Shenzen Xunlei Netwk Tech
Adscape Media Inc
Doubleclick
Tonic Systems
Video Conf. Software
Greenborder Tech Ltd
Panoramio.Com
Feedburner Inc
Peakstream Inc
Zenter
Grandcentral Communicat.
Postini
Beijing Feixiangren Informat
Zingku
Jaiku Ltd
Endoxon
Ilike.Com
Edodo.Com
Netclub
Insider Pages
Echomusic
Rqi Holdings Ltd
Front Line Mgmt
Emma Enterntainment Hold
Paciolon
Switchboard.Com
Backcountry.Com
Ibazar Com Br Ltd
Deremate.Com
Arbeidskamerater As
Aquantive
Screentonic
Jellyfish.Com
Newsvine Inc
Facebook Inc
Instadia
Touch Clarity
Offermatica
Visual Sciences Inc
Agoda Co
Make It About Me!
24/7 Real Media Inc
Shopping.Net
Mezimedia Inc
Mybloglog
Right Media Inc
Rivals.Com
Bluelithium Inc
Buzztracker.Com
Zimra Inc
Acquirer
Amazon.com Inc
Amazon.com Inc
American Greetings Corp
CNET Neworks
eBay
eBay
eBay
eBay
eBay
eBay
Expedia Inc
Expedia Inc
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
Idearc Inc
Liberty Media Interactive
MercadoLibre Inc
MercadoLibre Inc
Monster Worldwide
Microsoft
Microsoft
Microsoft
MULTIPLE ACQUIRERS
Microsoft
Omniture Inc
Omniture Inc
Omniture Inc
Omniture Inc
Priceline.com Inc
Shutterfly
WPP Group PLC
ValueClick Inc
ValueClick Inc
Yahoo! Inc
Yahoo! Inc
Yahoo! Inc
Yahoo! Inc
Yahoo! Inc
Yahoo! Inc
Seller
Cnet Networks Inc
Looksmart
Multiple Sellers
Marratech Ab
Gaylord Entertainment Co
Infospace Inc
Ebay Inc
Annc’d Tot
NA
NA
45
20.5
310
105
NA
75
NA
NA
NA
NA
NA
NA
NA
3100
NA
NA
NA
7
NA
NA
NA
NA
625
NA
NA
NA
NA
NA
NA
NA
NA
NA
109.12
NA
NA
NA
225
NA
NA
NA
NA
5460.65
NA
NA
NA
240
14.41
48.5
65
390.27
NA
NA
580.67
26.28
100
340
NA
300
Participate Media
NA
350
Payment
Undisclosed
Cash
Cash
Cash
Cash
Cash
Cash
Cash
Cash
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Cash
Undisclosed
Cash
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Cash
Cash
Stock
Undisclosed
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Cash
Cash
Cash
Cash & Stock
Cash & Stock
Cash
Undisclosed
Cash
Cash
Cash
Cash & Stock
Undisclosed
Cash
Cash
Undisclosed
Status
Complete
Complete
Complete
Pending
Complete
Pending
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Pending
Pending
Pending
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Pending
Complete
Pending
Pending
Pending
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Pending
Complete
Complete
Pending
Source: Bloomberg, company reports, news reports
7
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Worldwide Growth and Economic Prosperity Creating an
Ever-Larger Consumer Base
JPMorgan estimates that GDP growth has been stronger outside the US than
domestically in all but one year since 2000. At the same time, worldwide Internet
penetration has been growing rapidly, as well. As such, we believe that, for larger
Internet companies, the importance of the US, while remaining high, will continue to
fade in relative terms in coming years.
Table 5: JPMorgan’s Global GDP growth projections
World
Developed mkts
G-7
Emerging Econ.
Latin America
Emerging Asia
ex China
China
Emerging Eur.
ex Russia
Russia
Developed Eur.
World ex-US
United States
2001
1.6%
1.2%
1.0%
3.0%
0.5%
5.1%
2.7%
8.3%
1.6%
-0.6%
5.1%
1.9%
1.9%
0.7%
2002
1.9%
1.3%
1.2%
4.1%
0.1%
6.6%
4.8%
9.1%
4.5%
4.4%
4.7%
1.1%
2.0%
1.6%
2003
2.5%
1.8%
1.8%
5.0%
1.8%
7.2%
5.1%
10.0%
5.7%
4.7%
7.3%
1.1%
2.5%
2.5%
2004
3.8%
2.9%
2.8%
7.0%
6.2%
7.9%
6.3%
10.1%
6.8%
6.6%
7.2%
2.2%
3.8%
3.6%
2005
3.2%
2.4%
2.3%
6.3%
4.3%
7.8%
6.0%
10.4%
5.8%
5.5%
6.4%
1.8%
3.2%
3.1%
2006
3.6%
2.8%
2.7%
6.9%
5.3%
8.4%
6.5%
11.1%
6.4%
6.2%
6.7%
3.0%
4.0%
2.9%
2007E
3.4%
2.4%
2.2%
6.9%
5.1%
8.5%
6.3%
11.4%
6.3%
5.5%
7.5%
2.8%
3.9%
2.2%
2008E
3.0%
2.1%
2.1%
6.3%
4.5%
7.7%
5.8%
10.5%
5.8%
5.1%
6.8%
1.9%
3.2%
2.5%
2009E
3.4%
2.7%
2.7%
6.2%
4.4%
7.6%
5.9%
10.0%
5.7%
5.2%
6.3%
2.4%
3.5%
3.1%
Source: JPMorgan Economic and Policy Research
We believe the continued global GDP growth is creating an ever-expanding
consumer class. Twinned with the trend of rising Internet penetration, we believe an
ever-growing market opportunity exists outside the US for Internet companies,
especially those with the scale to invest meaningfully in their international
operations.
Internet companies are more
internationally diversified: we
estimate that ~64% of the
revenue of S&P 500 companies
is derived from US/North
American sales, compared to
less than 60% for large Internet
firms.
Table 6: Revenue Mix Is Shifting Away from US at Large Ad-driven, eCommerce and Travel Sites
% of revenue derived from US
Amazon (see note)
eBay
Expedia (see note)
Google
Priceline
Yahoo!
Total (revenue wtd)
2006
54.8%
52.1%
74.2%
57.0%
59.4%
75.0%
59.0%
2007E
55.0%
49.3%
70.0%
52.4%
44.9%
74.9%
55.8%
2008E
54.7%
47.5%
67.1%
50.6%
35.8%
73.5%
54.0%
2009E
54.0%
47.0%
64.6%
49.4%
29.8%
68.9%
52.4%
Source: Company reports, JPMorgan estimates
Note: For Amazon and Expedia, the percentage given is North America revenue share, rather than US.
In this respect, we believe Internet companies are somewhat ahead of the broader
market: based on FactSet data we estimate that ~64% of the revenue of S&P 500
companies is derived from US/North American sales.
We see no reason for the shift away from the US to abate in the near future, and as
such we believe that the large-cap companies in our coverage universe are likely to
retain at least a somewhat firm footing even if the US economy and US consumer
experience a slowdown. At the same time, given the significant exposure of these
companies to the US, we believe it would be a mistake to think of them as
“recession-proof”.
8
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Rising Broadband Penetration Remains Growth Catalyst
We believe faster Internet connections are necessary for a variety of online functions
– obvious ones such as media and gaming, but even eCommerce – to achieve
mainstream use. As such, we think rising broadband penetration across the world
remains a key catalyst for the growth of the companies in our coverage universe.
We note that, in the US, eCommerce spend as tracked by the Department of
Commerce has increased at a similar pace as Broadband penetration. We believe this
is not coincidental: speed is a key component of user experience, and a positive user
experience is likely to drive greater use of eCommerce sites.
Figure 2: US eCommerce has grown hand-in-hand with Broadband penetration
$ in millions; eCommerce quarterly average spend
30%
25%
30000
20%
20000
15%
10%
10000
5%
0
0%
1H'02
2H'02 1H'03
2H'03 1H'04
2H'04
eCommerce, $M
1H'05 2H'05
1H'06 2H'06
1H'07
Broadband Penetration, %
Source: Department of Commerce, OECD, JPMorgan estimates
OECD data suggests many countries in Continental Europe remain 1-2 years behind
the US and UK in terms of broadband penetration. As such, we think higher
broadband usage is likely to be a growth catalyst in those countries as well as in the
US in coming years.
While eCommerce has grown in parallel with Broadband penetration, online ad
spend, as measured by the IAB, has grown at a more rapid pace in recent years than
Broadband adoption:
Figure 3: US Online ad spend rising faster than Broadband penetration
$ in millions; IAB quarterly average ad spend
30%
5000
25%
20%
15%
2500
10%
5%
0
0%
1H'02
2H'02
1H'03
2H'03
1H'04
Ad spend, $M
2H'04
1H'05
2H'05
1H'06
2H'06
1H'07
Broadband Penetration, %
Source: OECD, IAB, JPMorgan estimates
9
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
We believe the faster rate of growth can be attributed in part to network effects: as
more users have access to a faster, more complete Internet experience, a greater
number of advertisers find it economical to direct part of their spend online. An
additional factor is the ability of richer media ads – which take advantage of higher
bandwidth – to command higher CPMs.
Newspaper Ad Spend Declining
Advertising spend at US newspapers is continuing to decline: 2007 saw an
acceleration of newspaper ad spend declines, and we think this trend is likely to
continue as time spent on newspapers declines in favor of time spent online. We
expect a continuation of the shift away from newspapers to be a tailwind for Internet
advertising in the coming year.
Figure 4: Newspaper Ad Spend Continues to Decline
$ in billions
4.0%
3.9%
55.0
1.9%
2.0%
1.5%
0.0%
-1.7%
-2.0%
-8.6%
45.0
44.9
46.7
47.4
46.6
-4.0%
-6.0%
42.6
-8.0%
-10.0%
35.0
2003
2004
2005
2006
2007
Source: NAA.org, JPMorgan estimates
Involvement of Regulatory Authorities Likely to Grow
As the industry grows and becomes entwined in more and more aspects of people’s
lives, we think regulators are going to take more and more notice of Internet
companies. Going forward, regulatory risk will likely grow, although we believe it
will remain relatively small, compared to other industries.
M&A in question
2007 saw several large mergers take place within the Internet space, most notably
Google’s purchase of DoubleClick and Microsoft’s acquisition of aQuantive. While
the latter was able to achieve regulatory clearance, European authorities are still (as
of mid-December) examining whether the Google – DoubleClick merger will create
a player in the online ad industry that is too dominant.
We think such regulatory flare-ups are likely to reoccur. Further, as online
advertising continues to take share away from traditional avenues, we expect the
incumbent players to pursue a variety of approaches, including lobbying for
regulatory/legislative intervention, to attempt to defend their position.
Privacy concerns abound
As search companies become larger and ad networks begin to capture more and more
data about users, privacy concerns have become more common.
10
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
In response, several companies have made voluntary steps to lower the quantity of
personalized data collection they do. For example, Google has said it will anonymize
searcher data after 18 months, while Ask has given users the option of erasing their
search history immediately.
Social networking sites, which often collect more personal information than do
search engines, have also faced attention in regards to their data practices. As we
note in the Social Networks Primer, below, we think history indicates that users are
willing to sacrifice incremental erosions of their privacy in exchange for features
they find useful, especially if sites do not over-reach. Thus far, the desire of users to
express themselves has been stronger than the desire to hide, and we think that is
likely to continue.
Internet Taxation: Likely Not on the Horizon in US
Two key Internet tax issues exist in the US: an Internet access tax and a sales tax. A
bill renewing the ban on an Internet access tax for seven years passed the US
Congress in October 2007.
As regards sales taxes on online retail sales, JPMorgan’s Senior Vice President for
Government Relations, Tom Block, believes that a recently proposed bill, intended to
allow states to implement an Internet sales tax under certain conditions, does not
have a significant chance of passing in the foreseeable future. While offline retailers
and state governors have lobbied for rules such as this, voting for this bill could be
construed as a tax increase, and Tom Block thinks that makes passage of the bill a
non-starter, especially in an election year.
Internet IPO Market Remains Healthy
2007 saw solid IPO activity in the Internet and online space, with deals in the double
digits (please see chart below). We believe the trend is likely to continue in F’08, as
an ever-evolving marketplace gives rise to new opportunities.
Table 7: Selected Internet IPOs, F’07
$ in millions except per-share amounts
Pricing Date
06/26/07
10/02/07
07/17/07
03/21/07
11/16/07
06/07/07
08/09/07
07/19/07
07/25/07
02/15/07
05/16/07
02/08/07
03/08/07
Issuer Name
Comscore Inc
Constant Contact
Dice Holdings Inc
Glu Mobile Inc
Internet Brands Inc
Limelight Networks Inc
MercadoLibre Inc
Orbitz Worldwide Inc
Perfect World Co Ltd
Salary.com Inc
TechTarget Inc
U.S. Auto Parts Network Inc
Xinhua Finance Media Ltd
Symbol
SCOR
CTCT
DHX
GLUU
INET
LLNW
MELI
OWW
PWRD
SLRY
TTGT
PRTS
XFML
Amt ($mm)
101
123
221
86
48
276
333
510
217
69
115
115
300
Mkt cap ($mm)
457
433
805
327
334
1,192
752
1,244
894
158
508
298
883
% mcap
22%
28%
27%
26%
14%
23%
44%
41%
24%
44%
23%
39%
34%
Offering Price
16.50
16.00
13.00
11.50
8.00
15.00
18.00
15.00
16.00
10.50
13.00
10.00
13.00
Price, 12/7
36.13
21.69
10.01
5.33
7.99
8.01
43.77
9.87
31.53
13.27
13.66
8.59
6.80
Performance
119%
36%
-23%
-54%
0%
-47%
143%
-34%
97%
26%
5%
-14%
-48%
Source: Company reports, FactSet, JPMorgan estimates
We see the Internet landscape continuing to undergo changes in F’08. We expect
several types of companies to start achieving a level of scale and operational
visibility where a public offering makes sense. Particularly, we think the growing
maturity of sectors of the Internet previously thought to be not yet mature, such as
social networks, will spur deal activity.
11
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
We Think 2008 Could Bring Greater Profitability
In 2006, 12 of the Internet companies in our coverage universe saw EBITDA
margins decline, and nine had increases. In F’07, the numbers were reversed, with 12
risers and nine decliners. We think, as some of the companies in our universe reach
greater maturity, profitability becomes a higher priority than growth, and more
achievable, and are forecasting rising EBITDA margins at 16 of these companies in
F’08.
At the same time, we do not believe that, given the scale of these firms, the leverage
that can be achieved in the short term is significant: of the 16 companies whose
margins we expect to improve, we are modeling greater than 100 bps EBITDA
margin improvement at only eight.
Finally, we would note that, should an economic downturn in F’08 be more severe
than currently expected, it is possible that our projected margin levels could see
pressure.
Table 8: Change in EBITDA margins for the JPMorgan Internet Coverage Universe
AMZN
CNET
DHX
EBAY
EXPE
GOOG
IACI
INSP
INWK
LINTA
MELI
MNST
MOVE
NILE
OMTR
OWW
PCLN
SFLY
SOLD
VCLK
YHOO
2006
EBITDA mgn
Y/Y change
6.6%
-1.0%
20.8%
1.5%
35.0%
-0.4%
34.4%
-6.3%
27.3%
-3.2%
63.2%
-2.0%
15.2%
0.7%
-7.5%
-28.3%
9.0%
2.4%
36.3%
3.0%
14.2%
5.8%
25.1%
2.1%
8.4%
6.3%
8.9%
-0.8%
10.1%
24.1%
-8.3%
-8.3%
9.5%
2.3%
16.8%
-0.8%
8.3%
-19.5%
26.6%
-1.8%
41.8%
-0.3%
Source: Company reports, JPMorgan estimates
12
2007E
EBITDA mgn
Y/Y change
7.5%
1.0%
19.9%
-0.8%
41.4%
6.4%
33.1%
-1.3%
27.4%
0.2%
59.4%
-3.8%
13.6%
-1.6%
-3.9%
3.6%
9.3%
0.3%
35.2%
-1.1%
28.3%
14.1%
22.3%
-2.8%
9.8%
1.4%
9.5%
0.5%
16.0%
5.9%
11.6%
19.9%
11.5%
2.0%
17.4%
0.6%
5.7%
-2.6%
25.6%
-0.9%
37.4%
-4.4%
2008E
EBITDA mgn
Y/Y change
8.2%
0.7%
22.1%
2.2%
41.5%
0.2%
33.3%
0.1%
26.9%
-0.6%
58.5%
-0.9%
13.9%
0.2%
-11.2%
-7.3%
9.7%
0.4%
34.8%
-0.4%
32.1%
3.8%
29.0%
6.7%
13.0%
3.2%
9.3%
-0.1%
17.5%
1.6%
16.8%
5.2%
17.3%
5.8%
17.8%
0.5%
15.1%
9.4%
25.8%
0.2%
38.1%
0.7%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Dot.Khan’s Top Ten for 2008
1.
CPM growth rate will accelerate
2.
M&A market will remain robust
3.
Audience Fragmentation: Will the Ad Network strategy work?
4.
Domestic eCommerce growth will slow: Can Amazon continue to deliver abovemarket growth?
5.
Can Jerry Yang turn Yahoo! around?
6.
Mobile ads will be like video ads: A whole lot of talk, not a whole lot of $
7.
Booking fees are not going away: consider that USAirways just introduced fees
8.
Economic slowdown may impact profitability somewhat, but we expect margins
to stabilize
9.
Internet will continue to cannibalize Newspaper ad spend, which declined ~8%
in F’07
10. Battle of Facebook vs. MySpace: both will thrive, but we think Facebook will do
better
13
Imran Khan
(1-212) 622-6693
[email protected]
14
North America Equity Research
02 January 2008
U.S. Sector Outlooks
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 Search Advertising Outlook
Given a very strong 2007 performance, we are increasing our outlook for the global
paid search market heading into 2008. We now believe global paid search revenues
will reach $30.5B in 2008, up from our prior estimate of $26.2B. We believe that
2008 paid search growth will be driven by:
• International growth due to continued adoption of paid search as a marketing
vehicle
• Keyword price inflation due to increased volume in advertisements
• Volume growth driven by increases in web usage
• CTR improvement driven by improvements in relevancy
Within search, we continue to believe that Google will take volume market share
from competitors as we have greater faith in the company’s ability to execute
relevancy enhancements and technological improvements and in its superior brand.
However, we believe that on a dollar market share basis, Yahoo! will grow its share
over Google due to the improved monetization from the global rollout of Project
Panama.
Yahoo! will grow its share over
Google due to the improved
monetization from the global
rollout of Project Panama.
We estimate that Google has a 73% dollar market share currently (including revenues
from AOL, Ask, and other affiliates). We believe that this may decline to 71% by
the end of 2008 as AOL and Ask have renegotiated their TAC rates and Yahoo! has
improved its monetization. While Internet and broadband usage appears to be
flattening out in developed countries, we believe that advertiser adoption of this welltargeted marketing vehicle is in its infancy and that there is still much room for
monetization and click-through rate improvements.
Lessons Learned from 2007
In our “Nothing but Net" preview and outlook for 2007, we stated that we preferred
paid search to other Internet sub-sectors such as e-commerce, travel, and graphical
advertising. Looking back on the year, paid search actually exceeded our
expectations. Entering 2007, we expected the paid search market to grow 39% over
2006 (29% in the US and 52% internationally). However, due to better monetization
by Google, Yahoo!, and MSN, as well as volume gains, we now expect global paid
search revenues to grow 48% in 2007 (37% in the US and 64% internationally). We
were surprised by how robust search volume growth was during F'07. At the
beginning of the year we thought that much of F’07’s US search market growth
would come from increases in coverage and were modeling a 190 bp improvement in
coverage vs. 18% Y/Y growth in search volume. We now think that F’07 US
coverage will only improve 70 bps vs 25% growth in volume. We are encouraged by
this trend as it demonstrates that the market is less mature than we thought and that
search companies have not had to resort to increasing the number of ads on a page.
Global Search Overview: Global Search Expected to Grow
39% in F’08
We believe 2008 will be another strong year for global paid search. On the back of
48.3% growth in 2007, we forecast that global paid search revenues will grow 38.7%
17
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
in 2008. From a metrics standpoint, we believe query volumes will grow 29.9% in
F’08, while RPS will grow 6.8%. We believe substantial monetization opportunities
exist and we anticipate a climb in search usage. In 2008, we expect local search,
personalized search and vertical search to be hot topics. Beyond 2008, we expect the
global paid search market to grow at a 28.4% CAGR through 2011.
Table 9: JPMorgan's Global Search Advertising Revenue Forecast
Units as indicated
Global
2002
2003
2004
2005
2006E
2007E
2008E
2009E
2010E
2011E
Internet Population (M)
Queries / Month / User
Number of Queries (M)
RPS (per 1,000 searches)
% Coverage
% Clickthrough Rate
$ Revenue / Click
Global Search Forecast ($M)
Y/Y Growth
593
12
83,030
$14.57
31.7%
15.1%
$0.30
1,210
197.0%
710
17
142,017
$19.04
35.3%
16.3%
$0.33
2,704
123.4%
820
22
220,128
$23.42
38.7%
17.3%
$0.35
5,156
90.7%
924
29
323,827
$28.17
41.7%
18.8%
$0.36
9,121
76.9%
1,020
36
441,796
$33.58
43.9%
20.6%
$0.37
14,835
62.6%
1,113
44
585,395
$37.58
44.5%
21.5%
$0.39
21,999
48.3%
1,205
53
760,474
$40.12
44.5%
22.2%
$0.41
30,511
38.7%
1,295
61
943,475
$41.98
45.2%
22.7%
$0.41
39,606
29.8%
1,380
68
1,123,558
$44.75
45.6%
23.5%
$0.42
50,275
26.9%
1,471
74
1,313,311
$45.59
47.1%
23.3%
$0.42
59,868
19.1%
07-'11
CAGR
7.2%
14.2%
22.4%
4.9%
1.4%
2.0%
1.4%
28.4%
Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS
Increasing F’08 US Search Growth Estimate: Now We
Expect to Grow 32%
Based on out-performance in 2007, we are increasing our 2008 growth estimate for
the domestic paid search market. We are now modeling 31.9% growth in 2008, up
from our prior estimate of 19.9%. Broken down by metrics, we are modeling US
query volume growth of 23.5% in 2008 (a very minor deceleration from the 25.4%
we observed in 2007), driven by an increase in the number of searches conducted per
user and a slight increase (3.0%) in the domestic Internet population.
We expect the domestic RPS to
reach $87.21 in 2008, up from
$81.65 in 2007 (6.8% Y/Y growth)
On the monetization front, we expect the domestic RPS to reach $87.21 in 2008, up
from $81.65 in 2007 (6.8% Y/Y growth). We expect increases in RPS to be driven
by advertiser demand for keywords as well as continued increases in sponsored-link
relevancy.
Table 10: JPMorgan's US Search Advertising Revenue Forecast
Units as indicated
United States
Internet Population (M)
Queries / Month / User
Number of Queries (M)
RPS (per 1,000 searches)
% Coverage
% Clickthrough Rate
$ Revenue / Click
US Search Forecast ($M)
Y/Y Growth
2006
2007E
2008E
2009E
2010E
2011E
203
47
114,896
$74.86
62.8%
26.2%
$0.46
8,602
47.2%
211
57
144,080
$81.65
63.5%
27.3%
$0.47
11,764
36.8%
217
68
177,938
$87.21
64.2%
28.3%
$0.48
15,518
31.9%
222
81
215,305
$88.73
64.3%
28.6%
$0.48
19,104
23.1%
227
92
249,754
$94.62
64.3%
30.0%
$0.49
23,631
23.7%
231
102
282,222
$94.91
64.5%
30.0%
$0.49
26,786
13.4%
07-'11
CAGR
2.4%
15.6%
18.3%
3.8%
0.4%
2.4%
1.0%
22.8%
Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS
Our Proprietary Research Shows...
Market Share Shifts Are Likely to Continue
In November, the JPMorgan Internet Team surveyed over 1,200 US residents to
determine Internet usage behavior. Our market research found that Google is the
dominant search engine with 54.6% of participants listing it as their most frequently
used search engine. Yahoo! ranked second among participants with 21.8% of
18
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
participants using it most frequently. MSN and AOL trailed with 8.6% and 7.2% of
participants using them most frequently, respectively.
Figure 5: Most Frequently Used Search Engine
% of participants
Don't use/Don't
Other
know
3%
2%
Yahoo!
AOL
7% Ask
3%
22%
MSN
9%
Google
54%
Source: JPMorgan research
However, we note that while Google was the overwhelming favorite among
participants, 38.5% of respondents use search engines other than their favorite at
least 30% of the time. Thus, it appears that respondents are willing to try different
search engines for better results.
44% of participants older than 42
used a search engine other than
their favorite more than 30% of
the time vs. only 32% of
participants in the 18-41 age
category.
Surprisingly, older participants were more likely to try different brand search engines
than younger participants. 44% of participants older than 42 used a search engine
other than their favorite more than 30% of the time vs. only 32% of participants in
the 18-41 age category. This difference was statistically significant (t=-4.37, p<.05).
62% of Respondents Would Be Willing to Consider Switching Search Engines
When asked what improvements by other search engines would cause you to switch
from your preferred brand, only 38% of respondents stated that nothing would cause
them to switch as they were satisfied with their current search engine. The most
frequently selected improvement was results that better matched the search term,
with 43% of respondents stating that this would cause them to switch search engines.
Other factors that would cause respondents to consider switching search engines
were the user-friendliness of the site (28% of participants) and search engine speed
(28% of participants).
Table 11: Factors that Would Cause Search Engine Switching
Results that better match search term
Results that include video, music, and other forms of information
A more uncluttered easy to navigate site
Ability to preview web content
Faster response speed to searches
Other
Nothing, happy with current search engine
% of Respondents
42.9%
14.2%
27.8%
22.5%
27.5%
1.7%
37.6%
Source: JPMorgan research
19
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
What would make participants try a different search engine? Friend and family
recommendations held the most weight, with 33.8% of respondents stating this as a
driver to try a new search engine. 21.7% of respondents stated that the
recommendation of a tech expert would influence them to try a new engine. Trailing
in the rankings of persuasiveness were TV ads (11.3% of respondents), billboards
(4.1% of respondents), newspapers and magazines (7.7% of respondents), and radio
(3.5% of respondents).
Over Half of Respondents Use Their Toolbar for Less than 40% of Searches
Approximately 75% of respondents to our survey use a search toolbar. Google was
the predominant choice of toolbars, with 40.7% of respondents having downloaded
it. Yahoo! came in second with 24.1% of respondents having downloaded it. MSN,
Ask, and AOL all had under 10% usage by respondents. Surprisingly, while almost
three-fourths of our respondents had toolbars, their usage of them was infrequent.
42.4% of respondents who had toolbars used them less than 20% of the time.
Figure 6: Toolbar Usage Frequency
% of respondents
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
Less than 20%
21-40%
41-60%
61-80%
81-100%
Source: JPMorgan research
International Market to Top the US by F’09
We continue to believe the opportunities for paid search in the international
marketplace are even more significant than in the US. In our estimate, while the
U.K. is at par or ahead of the US market, the overall international paid search market
is still 2+ years behind the US in terms of development.
We expect the international
market to reach $20.5B in F’09
vs. the US market size of $19.1B.
20
However, we now believe that the international market will be larger than the
domestic market in F’09 with a market size of $20.5B vs. the US estimated market
size of $19.1B. As such, we believe that the international markets will be a key
growth driver in the upcoming year. We believe a key driver in the international
markets will be query growth. While we expect the US to experience query growth
of 23.5% Y/Y, we believe international markets will see a 32% Y/Y lift in the
number of queries.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 7: US vs. International Query Volume
millions
200,000
180,000
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
3Q06
4Q06
1Q07
U.S.
2Q07
3Q07
International
Source: comScore data and JPMorgan estimates
We are modeling paid search revenues to grow 46.5% in F’08, up from our prior
estimate of 34.9% driven primarily by higher growth in queries and, to a lesser
extent, monetization gains. Broken down by metrics, we are modeling international
query volume growth of 32.0% in 2008 (a very minor deceleration from the 35.0%
we observed in 2007), driven by an increase in the number of searches conducted per
user and an increase (9.5%) in the domestic Internet population. On the monetization
front, we expect the international RPS to reach $25.74 in 2008, up from $23.19 in
2007 (11.0% Y/Y growth). We expect increases in RPS to be sustainable as the
international market RPS is significantly below US levels ($81.65 in F’07). Gains
will likely be driven by advertiser demand for keywords as well as continued
increases in sponsored-link relevancy.
Table 12: JPMorgan's International Search Advertising Revenue Forecast
Units as indicated
International
2006E
2007E
2008E
2009E
2010E
2011E
Internet Population (M)
Queries / Month / User
Number of Queries (M)
817
33
326,900
903
41
441,315
988
49
582,536
1,072
57
728,170
1,153
63
873,804
RPS (per 1,000 searches)
% Coverage
% Clickthrough Rate
$ Revenue / Click
Int'l Search Forecast ($M)
Y/Y Growth
$19.07
37.2%
17.2%
0.30
6,233
90.1%
$23.19
38.3%
18.4%
0.33
10,235
64.2%
$25.74
38.5%
19.1%
0.35
14,993
46.5%
$28.16
39.5%
19.8%
0.36
20,502
36.7%
$30.49
40.2%
20.5%
0.37
26,644
30.0%
1,239
69
1,031,0
89
$32.08
42.3%
20.5%
0.37
33,082
24.2%
07-'11
CAGR
8.2%
14.2%
23.6%
8.5%
2.5%
2.8%
2.9%
34.1%
Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS
21
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 Graphical Advertising Outlook
After a difficult 2007 where CPMs were pressured from a non-premium inventory
glut, we believe that 2008 will see stronger graphical advertising growth.
Specifically, we think that 2008 growth will be driven by:
• Easier comps as growth will be computed off of this year’s depressed CPMs
• Improving CPMs as companies employ targeting techniques and use ad
exchanges
• Improving RPMs due to higher sell-through and increased ads per page
• Increased advertiser interest due to the increased TV ad demand due to political
campaigns
• Increased page views from rising broadband usage and social networking
As a result, we are slightly increasing our F’08 graphical advertising global growth
estimate to 22.1% from 20.6% to reflect better monetization (CPMs) through the use
of targeting and exchanges and expected growth from social networking sites and
blogs. We favor web publishers who are organically growing their page views at a
rapid pace and who have targeting capabilities.
Lessons Learned from 2007
In our “Nothing but Net” preview and outlook for 2007, we expressed our view that
the US graphical advertising market was poised to grow 20% in 2007. Now that the
year is almost complete, we have revised our F’07 US growth estimate to 23.4%.
We believe that we correctly recognized the audience fragmentation trend due to the
rise of social networking and blog usage. We also forecasted the resulting depressed
CPMs from the glut of non-premium inventory. However, we did overestimate the
impact of video advertising. We thought that the increase in video inventory,
coupled with lower CPMs, would cause many graphical advertisers to shift their
advertising budgets toward video and away from more traditional graphical
advertising. We now recognize that reaching revenue sharing agreements and
developing unobtrusive video ads accepted by viewers will be a longer process than
we first thought.
Global Graphical Advertising Overview: Expect to Grow
22.1% in F’08
We believe that 2008 will be a strong year for graphical advertising publishers,
particularly those with targeting capabilities. On the back of expected 23.4% growth
in 2007, we believe global graphical advertising revenues will grow 22.1% in F’08.
From a metrics standpoint, we believe page views and RPMs will grow 11.1% and
9.9% in 2008, respectively. We expect the global Internet population to expand
8.3% to 1.2B in 2008 and web usage to expand by 2.7% per Internet user. We
believe RPM growth will be driven by (1) improving CPMs as companies employ
targeting techniques and use ad exchanges, (2) increased sell-through rates, and (3)
increased ads per page. We expect the global graphical advertising market to grow at
a 17.6% CAGR from 2007 through 2011.
22
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 13: JPMorgan's Global Graphical Advertising Revenue Forecast
Units as indicated
Global
Internet Population (M)
Pages Viewed / User / Day
Total Pages Viewed (B)
RPM (per 1,000 pages)
Global Graphical Forecast ($M)
Y/Y Growth
2002
2003
2004
2005
2006E
2007E
2008E
2009E
2010E
2011E
593
33
7,209
$1.02
7,354
-19.6%
710
34
8,897
$0.75
6,674
-9.2%
820
36
10,724
$0.81
8,642
29.5%
924
37
12,607
$0.87
10,984
27.1%
1,020
38
14,275
$0.97
13,829
25.9%
1,113
39
15,986
$1.07
17,068
23.4%
1,205
40
17,768
$1.17
20,846
22.1%
1,295
41
19,563
$1.26
24,561
17.8%
1,380
43
21,469
$1.33
28,573
16.3%
1,471
44
23,487
$1.39
32,685
14.4%
07-'11
CAGR
7.2%
2.7%
10.1%
6.8%
17.6%
Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, IAB
We Think that US CPMs Will Rise in 2008
We expect the US graphical advertising market to grow 19.9% in 2008, slightly
below our estimate from a year ago. We believe that page view growth will slow to
6.5% in 2008 (down from 8.0% in 2007) as social networking sites and blogs begin
to mature and reach saturated penetration levels. In our estimate, page view growth
will be driven by an increase of 3.0% in Internet users and an increase of 3.4% in
usage per Internet user. We are modeling RPMs to grow 12.6% in 2008, driven by
an 8.3% increase in the number of ad impressions per page view and a 3.9% increase
in CPMs. We expect the US graphical advertising market to grow at a 14.2% CAGR
from 2007 through 2011.
Table 14: JPMorgan's US Graphical Advertising Revenue Forecast
Units as indicated
United States
2006
2007E
2008E
2009E
2010E
2011E
Internet Population (M)
Pages Viewed / User / Day
Total Pages Viewed (B)
Impressions / Page
Total Impressions (B)
CPM (per 1,000 impressions)
RPM (per 1,000 pages)
US Graphical Forecast ($M)
Y/Y Growth
203
45
3,341
0.50
1,671
$3.50
$1.75
5,847
23.0%
211
47
3,608
0.60
2,165
$3.31
$1.99
7,166
22.6%
217
49
3,843
0.65
2,498
$3.44
$2.24
8,593
19.9%
222
50
4,093
0.68
2,783
$3.60
$2.45
10,019
16.6%
227
52
4,297
0.70
2,987
$3.76
$2.61
11,230
12.1%
231
53
4,512
0.70
3,158
$3.86
$2.70
12,192
8.6%
07-'11
CAGR
2.4%
3.3%
5.7%
3.9%
9.9%
3.9%
8.0%
14.2%
Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, IAB
Political Advertising Likely to Drive Up Scatter Inventory
We estimate that political ad spend on TV will total approximately $2.2B in the 2008
political cycle, up about 38% from 2006 levels. We estimate that presidential TV ad
spending alone should total over $600M in the 2008 election cycle. Since 1982,
political advertising revenues have contributed about 34% of spot TV ad growth in
even-numbered years.
Political advertising revenues
have contributed about 34% of
spot TV ad growth in evennumbered years.
Given the fixed quantity of available TV inventory and our expectation that political
ads may account for 6% of 2008 spot TV ads, we think that it is likely that some
advertisers will shift their ad spend to online display advertising.
23
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 15: Political Ad Spending, 1992-2008E
$ in millions
Presidential
+ Senate
+ House
+ Gubernatorial
+ Other
= Total Political Dollars Raised
x % $$ Spend
= Total Political Dollars Spent
x % Allocated to TV Advertising
= Political TV Advertising
% Change from Prior Election Year
1992
$331.1
$397.1
$530.7
$60.3
$263.7
$1,582.8
95.0%
$1,503.7
35.6%
$534.8
---
1994
$480.8
$573.6
$423.0
$232.6
$1,710.0
95.0%
$1,624.5
31.3%
$508.3
(4.9)%
1996
$425.7
$435.8
$653.5
$68.6
$310.2
$1,893.8
95.0%
$1,799.1
34.6%
$621.9
22.4%
1998
$455.1
$677.9
$471.0
$273.7
$1,877.6
95.0%
$1,783.7
40.1%
$714.4
14.9%
2000
$528.9
$547.5
$691.3
$97.8
$364.9
$2,230.4
95.0%
$2,118.9
41.0%
$868.9
21.6%
2002
$458.8
$761.8
$833.3
$285.5
$2,339.5
95.0%
$2,222.5
45.6%
$1,013.0
16.6%
2004
$880.5
$573.1
$784.8
$112.6
$406.3
$2,757.3
95.0%
$2,619.5
53.4%
$1,400.0
38.2%
2006
$664.8
$1,012.2
$937.9
$252.0
$2,866.9
95.0%
$2,723.6
58.7%
$1,600.0
14.3%
2008E
$1,454.4
$758.8
$1,160.5
$136.9
$447.0
$3,957.5
95.0%
$3,759.6
58.7%
$2,208.6
38.0%
Source: Opensecrets.org and JPMorgan estimates. Note: Other $$ includes funds raised by political parties, interest groups, etc.
Aggregators of Traffic Poised for Growth
While portals were once
dominant, Yahoo!, AOL, and
Microsoft only accounted for
~29% of minutes spent online in
August 2007, down from 42% in
August 2002.
Audience Fragmentation Creates Difficulty for Advertisers
While portals were once dominant, Yahoo!, AOL, and Microsoft only accounted for
~29% of minutes spent online in August 2007, down from 42% in August 2002.
Meanwhile, blogs, online gaming, and social networking websites have experienced
double to triple digit Y/Y growth rates in page views. This fragmented audience not
only makes it more difficult for advertisers to reach their target audience through
only a few publishers, but also makes it difficult for publishers to attract advertisers
given their limited scale. We believe that companies that can aggregate traffic
through the development of ad networks or partnerships will be more successful in
driving growth in 2008. Please see the Ad Network section of this report for
additional details.
Targeting Capabilities Successful on Inventory with Overlapping User Base
While increasing user reach is half the battle, we recognize that many page views are
meaningless to advertisers unless user information can be gathered and ads are
targeted. In order to most effectively target the ads, publishers need to have access to
user behavior on multiple sites to collect data and to repeatedly show ads to the same
user. We believe that companies with targeting capabilities will be able to command
a premium CPM. Revenue Science estimates that there is a 15x CPM premium for
behaviorally targeted ads.
24
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 8: Behavioral Targeting Effects on CPM
1600
80
1400
70
Tier 1
$10+
Tier 2
$1-10
Tier 3
< $1
Revenue Science
Targeting
~$10.00 - 12.00
1200
Average CPM Dollars
12
1000
10
800
8
600
6
Traditional optimized
ad network
$0.50 - 1.00
400
4
Exchange model
potential benefits
~$0.75 - 1.50
200
2
0
0
1
2
20
3
40
4
5
6
60
7
8
80
9
Web impressions Percent
Source: Revenue Science Presentation
International Growth Is Still a Big Theme
International markets continue to benefit from increased broadband penetration and
increased ad spend moving online. Even in markets where broadband is approaching
saturation, such as in the UK, display ad prices are likely to rise as more advertisers
compete for a more limited quantity of inventory. We estimate that international
display advertising will grow at 23.8% in 2008 and at a 19.9% 2007-2011 CAGR.
We estimate that international
display advertising will grow at
23.8% in 2008 and at a 19.9%
2007-2011 CAGR.
Table 16: JPMorgan's International Graphical Advertising Revenue Forecast
Units as indicated
International
2006E
2007E
2008E
2009E
2010E
2011E
Internet Population (M)
Pages Viewed / User / Day
Total Pages Viewed (B)
RPM (per 1,000 pages)
Int'l Graphical Forecast ($M)
Y/Y Growth
817
37
10,934
$0.73
7,982
28.1%
903
38
12,378
$0.80
9,902
24.1%
988
39
13,925
$0.88
12,254
23.8%
1,072
40
15,470
$0.94
14,542
18.7%
1,153
41
17,172
$1.01
17,344
19.3%
1,239
42
18,975
$1.08
20,493
18.2%
07-'11
CAGR
8.2%
2.8%
11.3%
7.8%
19.9%
Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, IAB
25
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Ad Networks on the Rise
What Are Ad Networks?
We see ad networks defined by the following:
Lead generation is more vertical
specific and performance
oriented than ad networks
¾
transacts, serves, tracks and reports the distribution of advertiser ads to
publisher pages.
¾
enables marketers to advertise on multiple publisher sites through one
central location
¾
publishers enjoy the benefit of advertising revenue without investing in a
sales force or as a source to sell remnant inventory
¾
varies in the ability to target a specific audience and in methods of payment
(CPM, CPC, and CPA)
¾
revenues are determined by revenue share agreements
The definition of ad networks is fuzzy with lead generation sometimes included.
However, we are differentiating between the ad network and lead generation space.
We are defining lead generation as much more targeted and deep into specific
verticals. As a result, we believe that this commands much higher CPM's, in the
$100-$150 range. While we believe that this is also an interesting ad model, we
believe it deserves a more detailed consideration and will thus save it for a later note.
A Significant Market Opportunity
We estimate that the global graphical advertising market as a whole will grow over
22% through 2008. The sector should benefit from 1) increased online viewership as
more people turn to the Internet as a source of content and 2) increased RPMs as
audience targeting improves.
Int'l Ad Network penetration is
so small that it is not yet tracked
by ComScore. We expect that it
is ~3-5 yrs developmentally
behind the US and will be a
significant future growth driver.
26
Additionally, increasing keyword prices and the ability of networks to provide
response advertising in addition to branding campaigns will likely drive more
marketers to ad networks. On the publisher side, as the long tail of information is
increasing, more publishers are looking to monetize their content. We estimate that
the top 20 ad networks will earn approximately $2B+ in revenue in 2007 (~14% of
the display ad market) and are growing much faster than the general graphical
advertising industry. We estimate ad networks to contribute ~17% of the total
display ad market in 2010 (25% F’08-F’10 CAGR).
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 9: Global Ad Network Market Forecast
$ in millions
6000
5000
4000
3000
2000
1000
0
2005
2006
2007E
2008E
2009E
2010E
Source: ComScore data, Company reports, and JPMorgan estimates
Table 17: Ad Networks by Page Views
millions
Advertising.com
AdBrite
Traffic Marketplace
ValueClick
24/7 Real Media
Tribal Fusion
CPX Interactive
Casale Media Network
Blue Lithium
Specific Media
Vibrant Media
ContextWeb
PrecisionClick
Burst Media
DRIVEpm
Interclick
Kontera
adconion media group
AdDynamix.com
Undertone Networks
Indieclick
Rydium Network
Total
August Page Views (M)
72,598.6
28,529.9
25,629.0
22,732.2
13,532.5
10,829.5
9,764.1
9,575.9
5,450.2
5,407.0
5,096.6
5,065.6
4,497.8
3,746.3
2,993.1
1,992.1
1,894.7
943.6
918.3
441.2
175.8
27.3
231,841.3
August Y/Y Growth
56%
901%
321%
64%
104%
-4%
N/A
-59%
211%
N/A
168%
122%
-52%
26%
140%
N/A
N/A
N/A
264%
734%
N/A
-52%
77%
Source: ComScore and JPMorgan estimates
The Future of Ad Networks
The ad network space is becoming increasingly competitive as new ventures are
launched and as Google, Yahoo!, AOL, and Microsoft enter the space through
acquisitions. We believe that differentiation will be key to success. Following are
capabilities that we see important to market leadership.
Behavioral targeting will
increase CPMs and drive
volume.
Behavioral Targeting
We believe that advertisers used to pay for audiences on websites but will now start
to pay for specific users. Marketers appear to value targeted advertising as evidenced
by Google’s well targeted search ads generating RPQs of more than double Yahoo!'s.
27
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
We expect that this same principal will apply to graphical advertising and note that
Revenue Science estimates a 15x CPM premium for behaviorally targeted ads.
Figure 10: Behavioral Targeting Effects on CPM
1600
80
1400
70
Tier 1
$10+
Tier 2
$1-10
Tier 3
< $1
Revenue Science
Targeting
~$10.00 - 12.00
1200
Average CPM Dollars
12
1000
10
800
8
600
6
Traditional optimized
ad network
$0.50 - 1.00
400
4
Exchange model
potential benefits
~$0.75 - 1.50
200
2
0
0
1
2
20
3
4
40
5
6
60
7
8
80
9
Web impressions Percent
Source: Revenue Science Presentation
We believe that the development
of a non-intrusive video ad
delivery system with contextual
advertising capabilities will be
valued by the ad network space.
Success in mobile ads will be
dependent on targeting, nonintrusiveness, and ability to load
on slow-loading platforms.
We see payment structures
shifting with objectives to
include CPA models in addition
to CPMs.
We believe marketers will turn to
targeted email distribution given
its high usage and push vs. pull
ad model.
28
Video Capabilities
Google’s $1.65B acquisition of video sharing site YouTube gives insight into the
value placed on video property. Traditional media companies have also moved onto
the Internet by offering TV episodes online and with Internet designed webisodes.
However, monetization of Internet videos has trailed its growth. Various companies
have experimented with pre-roll, post-roll and in-video ads. Google has
experimented with in video ads on select YouTube videos in which the ad is overlaid
on the bottom 20% of the video soon after it is launched. If the user does not click
on it, it simply disappears.
Mobile Ads
An even younger industry is mobile phone advertising. The development of the
iPhone and speculation of Google phone devices or services have placed a growing
interest in the field.
Performance-based Advertising
While many graphical ads were originally used for branding purposes with less of a
focus on conversion, the developments in behavioral and contextual advertising have
put more pressure on ad networks to deliver conversions.
Email Marketing
Ad networks have entered the realm of email marketing by placing advertisements in
emails sent by other companies to their customers. As in the other categories, ROI is
enhanced by careful pairing of the ad with a related company or email content.
Email marketing is a preferred method of advertising with its easy trackability and
ROI calculation. Furthermore, unlike other advertisements, email is pushed to
targeted customers rather than assuming that specific websites will pull these
customers to the ad.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Ultimately, we believe successful ad networks are going to need to be able to provide
a diversity of advertising platforms to its marketers with clear targeting capabilities.
Dominant Portals’ Role in the Growing Ad Network Market
In our view, potential consolidation in the ad network space is strategically feasible.
We believe that consolidation will occur throughout the industry as ad networks
grow their user base and leverage user information through behavioral targeting
across a larger audience base. We believe large portals are well positioned as it is
easier for both advertisers and publishers to fulfill all of their needs on fewer
platforms while a consolidated network yields greater leverage of technology and
advertiser/publisher relationships.
Minutes spent on portals has
declined over the last 5 years
despite 37% growth in total
minutes spent on the Internet.
Creating Ad Networks Could be the Answer to an Ever-Fragmenting Audience
While portals were once the dominant source of news and information, Yahoo!, AOL
and Microsoft only accounted for ~27% of total minutes spent online in October vs.
42% in 2002. A similar trend can be seen in page views as October page views on the
top 3 portals declined 22% from October 2004 vs. 22% total Internet growth in page
views. We note that some of these losses can be attributed to losses in dial-up subs.
We believe portals will become more significant players in ad networks as they turn
to networks to grow their user reach, leverage user information through behavioral
targeting, and leverage their existing capabilities to sell, place, and analyze display
ads.
Figure 11: Total Minutes Spent on Portal in October 2002 and 2007
millions
60,000
50,000
43% decline
34% growth
40,000
21% decline
30,000
20,000
10,000
0
Yahoo! Sites
Time Warner Network
Oct '02
Microsoft Sites
Oct '07
Source: ComScore data and JPMorgan estimates
29
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 12: Total Page Views for Leading Portals, October 2004 and 2007
millions
45,000
7% decline
40,000
54% decline
35,000
30,000
4% growth
25,000
20,000
15,000
10,000
5,000
0
Yahoo! Sites
Time Warner Network
Oct '04
Microsoft Sites
Oct '07
Source: comScore data and JPMorgan estimates
If a company had demographic,
search query, and web
navigation data on a user, we
believe it could provide
advertising that is more user
relevant and could tailor the ads
to the user as he/she navigates
the web.
User Information Will Lead to Dominance
Accurate and rich user information is among an Internet company’s most valuable
assets. Additionally, the ability to leverage accurate user information to deliver
relevant content to users is the key to increasing conversion rates. We think large
cap companies are particularly well suited to running ad networks as they can lever
their user information with that of the publisher network to provide well targeted
advertising. This should increase user conversion and monetization capabilities. A
combination between any of the search players, a large publisher network, and a
company with behavioral targeting capabilities would make sense, in our view.
One Platform for Multiple Advertising Products=Higher Ad Dollar Allocation
From the standpoint of an advertiser, advertising campaign management would be
easier with a single ad firm offering multiple products (search, graphical, cost-perlead, cost-per-action, in-game advertising, mobile advertising, video). Publishers
would benefit from the scale of various advertisers across verticals and the higher
CPMs accompanying better targeted ads.
30
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 13: Online Advertising Services by Company
Service
AOL
GOOG
MSN
YHOO
Search
Ad Network
Ad Serving***
Traffic Exchange***
Targeting
Lead Generation
Affiliate Marketing***
Rich Media
Mobile
Email
***Assumes DoubleClick/Performics acquisition
Source: JPMorgan estimates, Company data
Cost Synergies
Entering the ad network space would allow large cap Internet companies to lever
their existing sales force, technology, and publisher relationships in expanding their
product offering. The sales team could expand its offering of graphical advertising to
include properties on the ad network. Technology used to place graphical ads on
owned and operated properties and for behavioral targeting could be extended for use
on network sites. Finally, search network relationships could be leveraged in
building the ad network.
Scale Is Critical to Build a Market-Leading Product
While we have established that the goal of ad networks should be to increase their
exposure to an overlapping user base across a variety of properties for targeting, such
an undertaking requires scale.
¾
Small Companies must choose between generalization across a variety of
publishers or going deep into a few verticals. Both options carry risk, as
generalization limits targeting capabilities while focusing on limited
verticals exposes companies to industry risk (for example, the current
mortgage industry weakness).
¾
Large Cap Companies, however, have the resources to be both broad and
deep, offering targeting capabilities while maintaining diversification of
risk.
AOL
Advertising.com revenue growth is not dependent on AOL usage trends
Advertising.com has been a major contributor to advertising revenue growth in the
past 12 months, driving 43% of ad revenue increase at AOL while accounting for
27% of total advertising revenue. Because its revenue is derived from placing thirdparty advertising on third-party sites, Advertising.com grew mainly through
acquisition of new customers rather than through improved monetization of AOL
traffic.
31
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 14: Advertising.com has contributed the largest portion of Y/Y advertising revenue
increases
$ in millions
80.0
63.0
50.0
60.0
40.0
39.0
40.0
60.0
50.0
75.0
74.0
55.7
51.8
38.0
34.0
29.0
35.0
9.0
20.0
0.0
Q2-06A
Q3-06A
Search
Q4-06A
Graphical
Ad.com
Q1-07A
Q2-07A
Source: Company reports and JPMorgan estimates.
We think that Advertising.com will continue to grow faster than AOL’s search and
graphical revenue streams, helped by an industry-wide shift to more targeted
adverting, increased CPM due to behavioral targeting added through acquisition of
TACODA as well as overall Internet advertising market growth.
Figure 15: We expect Advertising.com revenue to continue growing faster than search and
graphical
%
40.0%
36.9%
30.0%
20.0%
20.1%
15.4%
13.4%
16.5%
18.0%
10.0%
0.0%
07E
Search
08E
Graphical
Adv ertising.com
Source: Company reports and JPMorgan estimates.
Acquisition of TACODA Adds Behavioral Targeting Capability
We believe that the acquisition of TACODA, a behavioral targeting network,
completed by AOL on September 6, ’07, makes sense strategically:
• The deal’s logic is consistent with our view that improved monetization of nonpremium inventory will continue to gain importance as premium inventory
pricing growth is slowing industry-wide.
• We expect TACODA technology to improve targeting at advertising.com thus
driving CPM and helping maintain revenue growth rates.
32
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
• Bringing behavioral targeting function in house is a prudent defensive move
given recent consolidation, in our view.
Recent M&A Activity Intensifies the Competitive Environment
As discussed above, we see acquisition of TACODA as a positive strategic
development that should help offset potential impact from the recent changes in the
competitive landscape, two deals in particular:
• Acquisition of Blue Lithium by Yahoo! We believe that Yahoo! used
advertising.com as well as other networks to monetize its non-premium
inventory, relationships that maybe scaled down following the acquisition of Blue
Lithium. Furthermore, we expect Yahoo! to combine Blue Lithium with a
recently acquired ad exchange, Right Media, and pursue third-party business,
thus competing with Advertising.com.
• Acquisition of Aptimus by The Apollo Group (University of Phoenix Online).
The Apollo Group has been the single largest contributor to advertising.com
growth. We estimate that it accounted for 73%, 60% and 62% of Y/Y revenue
increase in Q3 ’06, Q4 ’06 and Q1 ’07, respectively. Although it's possible that
The Apollo Group will re-direct some of the inventory from ad.com to Aptimus,
we expect the gains from the integration of TACODA to at least offset any
potential impact.
Google
Becoming More than Just a Search Engine and Search Network
A latecomer to the display advertising field, Google has made recent strides to enter
it and, in our view, would be a likely candidate for building its AdSense network to
include display advertising. As the leader in search market share, Google has much
information about user preferences for hosting behaviorally targeted ads.
Table 18: Search Market Share, October 2007
millions
Core Search
Google Sites
Yahoo! Sites
Microsoft Sites
Ask Network
Time Warner Network
Searches
Oct-07
6,151
2,405
1,023
491
443
Search Market
Share
59%
23%
10%
5%
4%
Source: ComScore
Strategic Acquisitions Provide Fast-Paced Industry Entrance
Recent acquisitions have positioned it well to quickly gain market share. With the
pending acquisition of DoubleClick, Google gains ownership of two key
technologies:
¾
the DART suite: a comprehensive set of technologies that enable
advertisers to effectively manage their online advertising campaigns while
providing publishers with the ability to dynamically place ads on their sites.
¾
the DoubleClick Advertising Exchange: a platform for buyers to gain
immediate access to inventory with goal-based bid rules, defined budgets,
33
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
targeting, and frequency caps on inventory purchases, while sellers increase
overall yield by reducing unsold and undervalued inventory
DoubleClick has relationships with both publishers and advertisers that enable it to
serve hundreds of billions of ad impressions per year. In 2004 (the most recent fullyear data available), DoubleClick served over 800 billion online ad impressions (we
expect it will serve ~2 trillion impressions in F’07). Beginning with display
advertising tests within the AdSense for Content environment, Google has been
exploring the serving of graphical advertisements for a couple of years. But we
believe the acquisition of DoubleClick emphasizes the importance that Google places
on entering the ad network market.
Figure 16: Graphical Ad Market Will Represent 36% of Total in 2010
% of industry revenues
Graphical
Adv ertising
36%
Search Adv ertising
64%
Source: JPMorgan estimates, Company Reports, ComScore, Nielsen//NetRatings, IDC, IWS, IAB
MSN
Rich Targeting and Performance-based Advertising Capabilities
With the acquisition of aQuantive, Microsoft obtained the DRIVE performance
media platform, which provides premium advertising solutions to aQuantive
advertisers and agencies. With a selective inventory from only the top 250
publishers, DRIVEpm offers brand protection to its advertisers. The collection of
visitor data over several years and CPA payment options allows for behavioral
targeting and performance-based capabilities. While the selectivity of the publisher
network will likely limit its scale, this premium network will offer a point of
differentiation from competitive networks.
Figure 17: DRIVEpm Ad Network
Top 250
Publishers
Remnant
Inventory
DRIVEpm
Network
Source: aQuantive reports and JPMorgan estimates
34
Behavioral
Targeting
CPA Solution
Advertiser and
Agency Clients
Imran Khan
(1-212) 622-6693
imran.t.kh[email protected]
North America Equity Research
02 January 2008
AdECN Should Improve Monetization
In July, Microsoft announced its intention to acquire AdECN in 1H08. AdECN
serves as a hub for ad networks to buy and sell display advertising in a real-time
auction marketplace. Advertisers will get more access to inventory to enable better
matching to their requirements and increasing ROI. Publishers should be able to
increase their yield through increased volume of available inventory. With both
parties benefiting, AdECN should provide better monetization through higher CPMs
for Microsoft remnant and non-premium inventory. We believe this will be
instrumental in monetizing inventory from the Facebook and Digg partnerships.
Partnerships Are Growing MSN’s Display Reach Outside Its O&O Properties
Agreements to provide advertising on Facebook and Digg have expanded MSN's
advertising network beyond its owned and operated properties and have allowed
MSN to capitalize on the growing social networking trend. Facebook and Digg are
two of the fastest growing social networks with Y/Y page view growth well in excess
of 100%. The challenge that we believe Microsoft will face will be providing
targeting capabilities sufficient to monetize such a diverse user and content base.
Table 19: Partner Page View Growth, August 2007
millions
Aug-2006
501,260
6,463
4
Total Internet
FACEBOOK.COM
DIGG.COM
Aug-2007
474,003
15,260
24
Y/Y Growth
-5%
136%
496%
Source: comScore data and JPMorgan estimates
Yahoo!
A Clear Fit in the Ad Network Space
Yahoo! is particularly well positioned to provide targeted advertising to a network.
As the top-ranked website by unique visitors (according to comScore), Yahoo! has a
wealth of information about visitor habits and preferences.
Figure 18: Top Sites by Unique Visitors and % Reach, October 2007
thousands
160,000
75%
140,000
72%
66%
120,000
66%
100,000
46%
80,000
60,000
40,000
20,000
0
Yahoo! Sites
Google Sites
Time Warner
Network
Microsoft Sites
Fox Interactive
Media
Source: ComScore data
Yahoo! has made strategic acquisitions to build off its existing assets and to gain
dominance in this space.
35
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
¾
Its acquisition of Right Media, in addition to its owned and operated pages,
has made it a destination for the buying and selling of inventory.
¾
The acquisition of Blue Lithium has provided Yahoo! with behavioral
targeting technology, visitor information off its owned and operated sites,
advanced analytic reporting, and a sales force more accustomed to direct
response sales.
These additions should have a smooth integration as Yahoo! already possesses a
sales force accustomed to selling display and contextual advertising, has experience
with behavioral targeting with SmartAds, and has entered the ad network arena with
newspaper partnerships and agreements with eBay and Comcast. The acquisition of
Blue Lithium builds on these earlier efforts and has now made it a significant player
in the ad network space.
Ad Network Growth Yields F’08 Revenue Upside
Yahoo! has made significant progress in developing its own display advertising
partnerships. Most recently Yahoo! announced an agreement to collaborate with
Bebo on display and video advertising on the company's U.K. and Ireland sites.
Using a $1.00 CPM, 80% TAC and 50% Y/Y page view growth rate, we estimate
Yahoo!’s net take should be ~$16M. Given the high growth rate and the potential
that this partnership could expand to other geographic regions, we think this
agreement will yield additional long-term benefits.
Table 20: F'08E Partnership Revenue
$ in millions
Company
Comcast
The McClatchy Company
Calkins Media, Inc.
Media General, Inc.
Morris Communications
Paddock Publications, Inc.
Belo Corp
Cox Newspapers
The E.W. Scripps Co
Hearst Newspapers
Journal Register Company
Lee Enterprises
MediaNews Group, Inc.
eBay
Bebo
Total
Category
Cable
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Newspapers
Online auctions
Social Network
Source: ComScore, Company Reports, JPMorgan estimates
36
Partnership
Date
Ave. Monthly
Unique Users
(TTM)
4/30/2007
4/16/2007
4/16/2007
4/16/2007
4/16/2007
4/16/2007
11/20/2006
11/20/2006
11/20/2006
11/20/2006
11/20/2006
11/20/2006
11/20/2006
5/25/2006
9/12/2007
17.8
6.2
NA
1.9
NA
NA
4.0
3.4
16.1
7.2
NA
4.6
2.4
79.8
11.9
PV (last 12
Months
through
Apr.)
31,690
1,586
NA
288
NA
NA
1,242
1,089
4,778
119
NA
1,099
442
129,421
84,012
Estimated
Incremental
YHOO
Revenue
25.4
1.3
NA
0.2
NA
NA
1.0
0.9
3.8
0.1
NA
0.9
0.4
59.6
16.4
109.8
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Ad Exchanges: A New Marketplace
Ad Exchanges: A Response to Audience Fragmentation
One of the largest deterrents to the graphical advertising market has been the increase
in the difficult to monetize non-premium inventory. Social networking, blogs, photo
sharing, and email have all increased inventory levels but are difficult to monetize
given their non-targeted user base and lack of focus on ads. Ad Exchanges focus on
better monetizing this portion of inventory through aggregation and an open market.
While portals were once the dominant source of news and information, page views
on the top three portals declined 18% from August 2004 to August 2007 while the
total Internet market experienced page view growth of 21% during the same time
period. Much of this decline can be attributed to audience fragmentation, a result of
increases in non-premium inventory. Blogs, online gaming and social networking
websites like Facebook, MySpace and YouTube have been experiencing strong
growth in page views, with double- to triple-digit Y/Y growth rates.
Figure 19: Non-Premium Inventory Growth
Billions
MySpace
Facebook
15.26B Page views, Aug
136% Y/Y Growth
45.24B Page views, Aug
YouTube
38% Y/Y Growth
4.46B Page views, Aug
>100% Y/Y Growth
Blogs
Online Gaming
17.44B Page views, Aug
7.52B Page views, Aug
>100% Y/Y Growth
30% Y/Y Growth
Source: comScore and JPMorgan estimates
We believe that this audience fragmentation hampered the development of the
graphical advertising market as it resulted in the following challenges:
•
Audience fragmentation makes it difficult for advertisers to reach their target
audience through only a few publishers
•
Small publishers have difficulty attracting advertisers due to limited scale
•
Monetization is limited due to the difficulty of attracting sufficient advertisers to
cover available inventory (purchasing power)
Ad Exchanges have emerged as an efficient solution to these new challenges and are
gaining traction to alter the landscape for selling and purchasing display advertising
inventory.
37
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
The Rise of the Ad Exchange
The ad exchange is a real time marketplace with an auction-based system where the
participants - advertisers and publishers – transact on a common platform to purchase
and sell online graphical advertising. The publishers place remnant inventory on the
exchange for the advertisers to purchase through bidding on a user-friendly interface.
Network barriers are lowered and all participants interact on a common platform,
while the outside relationships are not disturbed. Ad Exchanges do not compete with
ad networks, targeting technologies, or publishers, but rather serve as a more
efficient way for the exchange of inventory within these groups.
Figure 20: Ad Exchange Linkages
Bid Optimization
Large Publishers
Contextual Networks
Targeting Technologies
Ad Exchange
Agency Side Ad Servers
Rich Media Vendors
Display Networks
Other Ad Exchanges
Source: www.clickz.com (Article: Ad exchanges are the future)
Key features of ad exchanges:
• Transparent and dynamic pricing landscape due to open bidding process
• Reduced operational friction due to improved clarity of placement of ad serving
on a website
• Enhanced efficiency due to simplification and standardization of business
processes
• Improved liquidity of ad inventory
• Interests of smaller niche players safeguarded as existing relationships and budget
sizes exert no influence and each bidder has equal access to the media
• Increased role of technology to automate and provide a common platform
• Elimination of intermediaries and their margins
The Value of an Ad Exchange
For Advertisers:
An advertising exchange establishes a transparent and automated clearinghouse,
easing pricing concerns. The advertiser can place different bids for each ad
impression after evaluation of the perceived value against the buy criteria. Thus, the
advertisers gain from:
38
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
• Smarter spending
• Better ROI
• Access for inventory for targeting purposes
For Publishers:
The ad exchange model will usher in more competition and enhanced technologies
for targeting. This should drive the demand for inventory upwards, resulting in
higher CPMs. The publisher can set a floor price for the impressions to be accepted
by the exchange and will gain as yields optimize when highest bids win in a real-time
auction. The benefits for the publishers are:
• Better targeting
• More valuable inventory
• Higher prices
• Better yield
Key Takeaways
•
Exchanges should increase CPMs for publishers as they provide an open auction
market to a large population of advertisers
•
Advertisers should gain easier access to a broad range of inventory, which can
be used for targeted advertising
• The major Internet players should become ad exchange operators as they strive to
provide a one-stop solution to all of an advertiser’s needs
39
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 eCommerce Outlook
2007 saw the standard-bearer of eCommerce, Amazon.com, accelerate revenue
growth for a second straight year as the company extended its presence in a variety
of categories and geographies. At the same time, we believe the online presence of
brick-and-mortar retailers such as Walmart and Target has taken a step forward, with
their sites growing penetration.
Looking forward to 2008, we expect competition to continue to heat up between
online and brick-and-mortar retailers. The biggest unknown is to what extent the US
economy sees a slowdown in ’08. Even in a slowdown, however, we think online
retailers are likely to continue to gain market share from offline retail channels.
2008 eCommerce Forecast
We think US growth in eCommerce (including eBay GMV) could experience weaker
Y/Y growth rates if economic conditions worsen. At the same time, we expect a
greater proportion of retail sales to continue to shift online, driven by (1) increases in
product selection, (2) continued Y/Y improvements for brick-and-mortar retailers
and (3) further improved efficiencies from site optimization.
Table 21: US eCommerce Forecast
units as indicated
US eCommerce Forecast
Internet population (M)
Online Shoppers
Shopping sessions / shopper / month
Total shopping sessions / year (M)
Average price / session
Total eCommerce revenue (US $M))
Product return rate
Net Revenue
Y/Y Growth
2004
186
104
1.92
2,394
$39.50
94,581
10.0%
85,123
2005
195
117
1.99
2,788
$41.25
114,991
9.0%
104,642
2006
203
130
2.08
3,241
$43.00
139,384
9.0%
126,839
2007E
211
143
2.10
3,614
$45.50
164,431
8.0%
151,277
2008E
217
152
2.23
4,074
$47.50
193,502
8.0%
178,022
2009E
222
162
2.40
4,658
$ 48.80
227,321
8.0%
209,135
2010E
227
173
2.59
5,363
$49.75
266,808
8.0%
245,463
22.9%
21.2%
19.3%
17.7%
17.5%
17.4%
'07 - '10 CAGR
2.5%
6.3%
7.3%
14.1%
3.0%
17.5%
0.0%
17.5%
Source: Department of Commerce, Internet World Stats, company reports, JPMorgan estimates
Note: includes eBay US GMV
Worldwide, we are projecting continued strong eCommerce growth. Note that, in
2007, the European growth rate had a ~10% impact from FX. Additionally, though
we have assumed flat FX going forward, the projected ’08 dollar-denominated
growth rate sees a boost as the $/Euro exchange rate at year-end was above the fullyear average.
For our international forecast, we expect the following drivers, some region-specific
and some general: (1) continued rises in online shopping penetration in Western
Europe, (2) continued investments by online retailers in broadening selection, (3)
improvements in shipping infrastructure, (4) improved payment systems and (5)
better fraud protection.
40
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 22: Global eCommerce Forecast
$ in millions
Global eCommerce Forecast
US
Europe
Asia
ROW
Total
Y/Y Growth
2004
85,123
85,827
29,538
9,440
209,927
2005
104,642
112,139
39,685
13,216
269,681
2006
126,839
139,126
50,556
18,502
335,024
2007E
151,277
179,226
63,340
25,903
419,745
2008E
178,022
224,911
77,899
36,265
517,096
2009E
209,135
257,748
94,686
47,144
608,714
2010E
245,463
289,966
114,673
61,287
711,390
28.5%
24.2%
25.3%
23.2%
17.7%
16.9%
'07 - '10 CAGR
17.5%
17.4%
21.9%
33.3%
19.2%
Source: Department of Commerce, Internet WorldStats, UK eStats, Forrester Research, Iresearch, Korea National Statistics Office, eMarketer, company reports, JPMorgan estimates
Large-Cap eCommerce Companies Growing Revenue
Faster
Both Amazon and eBay grew revenue at a faster pace than the US eCommerce
market as a whole. For eBay, international growth, as well as growth in PayPal, have
been key drivers. At Amazon, US revenues have grown faster in the US than
internationally, paced by growth in third-party sales and 50% growth in Electronics
categories in the first three quarters of F’07.
Table 23: eCommerce Industry Comparable Table -- Small and Large Cap Revenue Growth Rates
Market cap in $ millions
AUDIBLE INC
AMAZON.COM INC
EDIETS.COM INC
DRUGSTORE.COM INC
EBAY INC
1-800-FLOWERS.COM
FTD GROUP INC
MERCADOLIBRE INC
NAPSTER INC
NETFLIX INC
BLUE NILE INC
OVERSTOCK.COM INC
SHUTTERFLY INC
STAMPS.COM INC
Group Average
Large-cap Average
Small-cap Average
US E-commerce
Ticker
ADBL
AMZN
DIET
DSCM
EBAY
FLWS
FTD
MELI
NAPS
NFLX
NILE
OSTK
SFLY
STMP
Rating
NR
N
NR
NR
OW
NR
NR
OW
NR
NR
N
NR
OW
NR
Price
12/26
$9.02
$92.85
$5.90
$3.37
$34.49
$8.83
$13.30
$72.85
$1.95
$28.70
$74.16
$16.17
$27.38
$12.78
Mkt Cap
12/26
$220
$38,549
$147
$324
$46,683
$556
$383
$3,222
$90
$1,888
$1,190
$385
$675
$253
Y/Y Revenue Growth
'04/'05
'05/'06
'06/'07E
84%
30%
32%
23%
26%
35%
18%
-9%
-40%
11%
4%
8%
39%
31%
29%
11%
17%
26%
10%
6%
39%
84%
62%
-53%
103%
40%
35%
46%
21%
20%
24%
28%
63%
-2%
-1%
54%
47%
48%
62%
37%
3%
29%
32%
24%
31%
29%
32%
29%
32%
22%
22%
23%
20%
Source: Department of Commerce, Company reports, Reuters, JPMorgan est. for rated companies, FactSet estimates for other
companies. JPMorgan ratings: OW = Overweight; N = Neutral; UW = Underweight
Takeaways from the 2007 JPMorgan Internet Team’s 2007
Consumer Survey
In the second half of November, we conducted a proprietary survey of US
consumers. The survey had 1,261 participants, residents of the United States aged
18+. In addition to asking consumers about their shopping plans for the 2007 holiday
season, we asked the respondents a variety of questions about their online shopping
habits in general, and the key broad takeaways are summarized below:
Price is biggest factor in choosing a site
63% of shoppers said price was the biggest factor in choosing an online store, with
selection also important. Of the options we offered, the least popular one, by a wide
margin, was “recommendations from friends and relatives”.
41
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 24: Price is paramount: factors that influence buyers’ choices
% among respondents who indicated they shop online
Factor
Price
Selection
Customer service
Promotions/Advertisements
Payment options
Familiarity/experience with store
Name recognition
Ability to purchase multiple items
Access to customer reviews/product information
Recommendations from friends/relatives
#1 factor
63.0%
11.8%
3.9%
2.2%
2.3%
5.7%
2.7%
4.1%
3.2%
1.3%
#2 factor
13.7%
36.5%
9.1%
7.3%
7.8%
6.2%
6.3%
5.0%
4.6%
3.6%
In top 5
87.1%
74.3%
48.0%
43.4%
42.0%
40.9%
40.0%
37.8%
33.7%
23.1%
Source: JPMorgan Internet Team 2007 Consumer Survey
Looking at the data on a site-by-site basis does not change the conclusion: price
remains the top consideration for shoppers regardless of site, with 60-63% of
shoppers at each of Amazon, eBay, Walmart.com and Target.com listing price as
their top factor in choosing a site.
Higher-income shoppers look for slightly different things in a site. More than 50% of
shoppers with incomes over $100K listed “familiarity/experience with store” as one
of their top five factors, compared to below 40% for those earning less than $100K.
Selection and the ability to purchase multiple items were more important to those
with incomes over $100K, while payment options were less important. Even for the
>$100K-income shoppers, price is the biggest factor: fewer respondents in this
income category chose it as their #1 factor, but approximately 86% listed it in their
top five, in line with the sample as a whole.
Table 25: Familiarity and selection matter more to higher-income shoppers
% of online shoppers who indicated factor was one of their top 5 factors in choosing a site
Factor
Price
Selection
Customer service
Promotions/Advertisements
Payment options
Familiarity/experience with store
Name recognition
Ability to purchase multiple items
Access to customer reviews/product information
Recommendations from friends/relatives
Income <$100K
87.2%
73.6%
48.0%
42.7%
43.7%
39.5%
40.8%
37.1%
34.1%
22.9%
Income >$100K
86.2%
79.7%
48.0%
48.0%
29.3%
50.4%
34.1%
43.1%
30.9%
24.4%
Difference
-1.1%
6.1%
-0.1%
5.3%
-14.5%
10.9%
-6.6%
6.0%
-3.2%
1.5%
Source: JPMorgan Internet Team 2007 Consumer Survey
Walmart.com, Target.com catching up to large online sites
Third-party metrics indicate eBay and Amazon are the two largest online-only stores
in terms of unique users, whereas Walmart.com and Target.com are the two biggest
sites belonging to brick-and-mortar retailers. In ’06, only Amazon and eBay drew
business from at least 30% of our respondents, more than any other sites. For the ’07
holiday season, our survey shows no significant change in Amazon’s and eBay’s
reach, but strong growth for the two largest brick-and-mortar retailers’ sites, with
20+% increases in respondents planning to use Walmart.com and Target.com. We
also saw a significant increase in the number of users expecting to use
Circuitcity.com.
42
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 26: Respondents who used (’06) or plan to use (’07) specific sites for holiday shopping
Site
Amazon
eBay
Walmart.com
Target.com
Bestbuy.com
Circuitcity.com
QVC.com
HSN.com
2006
36.9%
30.0%
22.9%
15.3%
17.9%
9.1%
6.3%
4.5%
2007
36.2%
28.4%
27.8%
19.9%
18.6%
12.0%
5.9%
4.7%
Y/Y difference significant?
No
No
Yes, up 21% Y/Y
Yes, up 30% Y/Y
No
Yes, up 31% Y/Y
No
No
Source: JPMorgan Internet Team 2007 Consumer Survey. Statistical significance at a p<.01 level.
Media, Apparel top categories
Books, music and video were the top category, with nearly 66% of online shoppers
reporting they had bought such items online within the past year. Apparel and
accessories, at 57% penetration, was second, tilted predominantly toward female
shoppers. Unsurprisingly, men were much more likely to shop in both the Computers
and VideoGames category and the Electronics category.
Table 27: Media items popular with both genders: Top five categories among men and women
%, among respondents who indicated they shop online, that indicated they had made purchases in category
Men
Books, music, videos and other media
Computer and videogames software and
hardware
Apparel and accessories (includes shoes,
handbags and jewelry)
Electronics (includes television and stereo
equipment)
Health and beauty
63.7%
51.4%
46.5%
36.1%
24.3%
Women
Books, music, videos and other media
Apparel and accessories (includes shoes,
handbags and jewelry)
Health and beauty
Computer and videogames software and
hardware
Toys
67.0%
64.2%
38.2%
32.7%
32.2%
Source: JPMorgan Internet Team 2007 Consumer Survey
Younger users shop online more, and gap is widening
Among online shoppers, 29% of those aged 18-41 did more than 40% of their
holiday shopping online in ’06, and 39% expected to do so this year. Among those
aged 42+, the respective numbers were 17% and 20% for ’06 and ’07.
Figure 21: Expectation of money spent shopping online, holiday season ’07 vs. ’06
% among respondents who indicated they shop online
Ages 18-41
More,
Ages 42+
17%
More,
43%
About the
About the
same,
same,
51%
40%
Less,
Less,
16%
31%
Source: JPMorgan Internet Team 2007 Consumer Survey
43
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Internet Sales Tax: Likely Not on the Horizon in the US
In May 2007, Senator Mike Enzi (R-WY) reintroduced a bill designed to allow states
to collect sales tax from online sellers with revenues of $5M or more. The states must
agree to certain terms to simplify their sales tax regulations in order to take
advantage of the bill.
JPMorgan’s Senior Vice President for Government Relations, Tom Block, believes
that this bill does not have a significant chance of passing in the foreseeable future.
While offline retailers and state governors have lobbied for rules such as this, voting
for this bill could be construed as a tax increase, and Block thinks that makes passage
of the bill a non-starter, especially in an election year.
Catalysts for International Growth
We believe the rising tide of increased Internet use across the world is likely to help
lift eCommerce globally. However, we see three key challenges to overcome for
eCommerce to fulfill its potential:
•
Improvement of shipping infrastructure. Postal and parcel service in
many parts of the world can be unreliable, and a reliable distribution
channel is an essential prerequisite for the growth of eCommerce.
•
Improved payment systems. This is not a world-wide challenge, but rather
a slew of country-specific challenges related to the idiosyncrasies of
different countries’ banking systems and conventions. Even in more
developed countries, significant differences emerge: e.g., Germany and
Austria have seen much lower rates of PayPal use than other eBay
geographies due to the prevalence of bank transfers as a mode of payment
there. We note the August 2007, announcement that Alibaba’s Alipay
service will allow shoppers in China to buy products from non-China-based
sellers in a variety of foreign currencies. We think such developments will
eventually lead to a more fluid, interconnected global eCommerce market.
Table 28: PayPal Penetration on select eBay country sites
% of listings that include PayPal
Country
Canada
US
UK
Australia
Spain
Italy
France
Germany
Austria
Penetration
97.1%
95.5%
95.4%
72.1%
70.3%
67.8%
66.3%
33.5%
23.3%
Source: eBay.com (and country sites), JPMorgan estimates, data collected September - December, 2007
•
44
Better fraud protection. The promise of eCommerce has been one of lower
prices and/or better selection, with the trade-off that many purchases must
be made sight-unseen. The threat of fraud remains present, and structures
that insure buyers against fraud should help smooth operations in an
eCommerce environment that is not yet fully mature. (An example is eBay’s
PayPal, which provides up to $2K in fraud protection in the US to create
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
buyer confidence, with transaction loss rates for the PayPal unit of 25-33
bps, as denominated by total payment volume).
We note that the above is not intended to be an exhaustive list of catalysts for
international growth – many specific markets can present unique challenges – such as
governmental ones – for the operation of eCommerce companies.
45
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 Online Travel Outlook
In 2007, online travel agency companies continued to face slowing US growth due to
a maturing market and increased competition from suppliers and have come to rely
more heavily on growth from Europe. The companies in our coverage universe
continue to pursue their international growth strategies and have begun to position
themselves in the Asian market.
Looking to 2008, we expect to see the following dynamics shape the online travel
agency space: (1) acceleration of domestic growth as GDS air revenue declines are
anniversaried, (2) increased dependence on international growth, (3) a focus on
developing Asian markets as European markets mature, (4) higher sales and
marketing costs due to keyword inflation, and (5) investment in customer service,
technology and processes.
Online Travel Market Should Continue to Grow
US Online Travel Estimates
We believe US online travel growth in 2008 will be driven by: (1) increased travel
volume, (2) increased prices, particularly in hotel bookings where demand continues
to exceed supply, and (3) to a lesser extent, increased online vs. offline travel
booking.
Our updated market forecast calls for F’08 online travel gross bookings of $90.4B,
representing Y/Y growth of 9.5%. We are estimating domestic online travel gross
bookings to grow at a CAGR of approximately 7.5% through 2010.
Table 29: US Online Travel Market Projection
$ in millions
Average Price
Total Trips
Total Travel Spend
% online
Online Travel Spend
Average Price Growth
Total Trips Growth
Total Travel Spend Growth
Online Travel Spend Growth
2004
272.6
1,953.3
532,400.0
9.8%
52,400.0
2005
287.1
1,992.4
572,100.0
11.0%
62,800.0
2006
302.2
2,032.2
614,200.0
12.0%
73,400.0
2007
317.3
2,072.9
657,808.2
12.6%
82,600.0
2008E
331.6
2,114.4
701,157.8
12.9%
90,449.4
2009E
343.2
2,146.1
736,583.8
13.2%
97,229.1
2010E
350.1
2,178.3
762,585.2
13.5%
102,949.0
5.3%
2.0%
7.5%
19.8%
5.3%
2.0%
7.4%
16.9%
5.0%
2.0%
7.1%
12.5%
4.5%
2.0%
6.6%
9.5%
3.5%
1.5%
5.1%
7.5%
2.0%
1.5%
3.5%
5.9%
2007-2010 CAGR
3.3%
1.6%
5.0%
2.4%
7.5%
Source: JPMorgan estimates, PhoCusWright, eMarketer, Jupiter, and TIA
International Online Travel Estimates
Consistent with last year, many US companies are looking abroad to supplement
slowing US growth. We believe international online travel growth in 2008 will be
driven by (1) continued growth in online vs. offline bookings in Europe and Asia, (2)
increased inventory placed online, (3) international acquisitions to facilitate market
inroads, (4) continued investments in international operational infrastructure, (5)
increased broadband penetration in Europe and Asia, and (6) increased prices and
volumes.
46
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our updated forecast calls for F’08 European online travel gross bookings of $59.5B,
representing Y/Y growth of 18%. We estimate that European online travel gross
bookings will grow at a CAGR of approximately 16% through 2010.
Table 30: Europe Online Travel Forecast
$ in millions
2004
621.3
1,423.1
884,210.5
2.8%
25,100.0
Average Price
Total Trips
Total Travel Spend
% online
Online Travel Spend
Average Price Growth
Total Trips Growth
Total Travel Spend Growth
Online Travel Spend Growth
2005
627.3
1,480.0
928,421.0
3.6%
33,500.0
2006
642.0
1,552.0
996,333.0
4.2%
41,900.0
2007
652.9
1,629.6
1,063,934.2
4.7%
50,300.0
2008E
662.0
1,694.8
1,121,982.4
5.3%
59,465.1
2009E
668.6
1,762.6
1,178,530.4
5.9%
69,533.3
2010E
675.3
1,833.1
1,237,928.3
6.3%
77,989.5
1.0%
4.0%
5.0%
33.5%
2.3%
4.9%
7.3%
25.1%
1.7%
5.0%
6.8%
20.0%
1.4%
4.0%
5.5%
18.2%
1.0%
4.0%
5.0%
16.9%
1.0%
4.0%
5.0%
12.2%
2007-2010 CAGR
1.1%
4.0%
5.1%
9.9%
15.6%
Source: JPMorgan estimates, PhoCusWright, eMarketer, Jupiter, and IPK International
Our updated Asian F’08 forecast calls for online travel gross bookings of $43.6B,
representing Y/Y growth of 35%. We estimate that Asian online travel gross
bookings will grow at a CAGR of approximately 30% through 2010.
Table 31: Asia Online Travel Forecast
$ in millions
Asia Online
Travel Sales
Y/Y Growth
Rate
2004
2005
2006
2007
2008E
2009E
2010E
12,100.0
15,900.0
22,300.0
32,300.0
43,600.0
56,600.0
70,800.0
31.4%
40.3%
44.8%
35.0%
29.8%
25.1%
2007-2010
CAGR
29.6%
Source: JPMorgan estimates, PhoCusWright, eMarketer, and Jupiter
This adds up to an F’08 global online travel forecast of $193.5B, which is a 17%
increase from 2007. Our forecasted CAGR through 2008 calls for 15% growth.
Table 32: Global Online Travel Forecast
$ in millions
2004
2005
2006
2007
2008E
2009E
2010E
US Online
Travel Sales
Y/Y Growth
Rate
52,400.0
62,800.0
73,400.0
82,600.0
90,449.4
97,229.1
102,949.0
19.8%
16.9%
12.5%
9.5%
7.5%
5.9%
Europe Online
Travel Sales
Y/Y Growth
Rate
25,100.0
33,500.0
41,900.0
50,300.0
59,465.1
69,533.3
77,989.5
33.5%
25.1%
20.0%
18.2%
16.9%
12.2%
Asia Online
Travel Sales
Y/Y Growth
Rate
12,100.0
15,900.0
22,300.0
32,300.0
43,600.0
56,600.0
70,800.0
31.4%
40.3%
44.8%
35.0%
29.8%
25.1%
WW Online
Travel Market
Y/Y Growth
Rate
89,600.0
112,200.0
137,600.0
165,200.0
193,514.4
223,362.3
251,738.5
25.2%
22.6%
20.1%
17.1%
15.4%
12.7%
2007-2010
CAGR
7.5%
15.6%
29.6%
14.9%
Source: JPMorgan estimates, PhoCusWright, eMarketer, Jupiter, TIA.org, and IPK International
47
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Easing Domestic Comps but Keeping Market Share is Key
Air Monetization Should Stabilize
Throughout 2006 and 2007, online travel agency domestic growth suffered as GDS
renegotiations resulted in significantly lower commissions on air tickets. Early
reports of negotiated agreements directly with suppliers indicated the establishment
of variable compensation tied to the value delivered to the supplier. 2008 should
bring the first year of flattish comparisons on this new compensation structure,
resulting in slightly easier domestic comps. However, we note that intense
competition from suppliers may put further pressure on pricing. Priceline has
decided to completely eliminate its domestic booking fees on air tickets. While
Expedia and Orbitz do not currently plan to follow suit, the increased competition
may further pressure their future volume or pricing strategies.
Figure 22: Domestic Revenue as a Percent of Gross Bookings Trends at the Top 4 OTAs
14.5%
14.0%
13.5%
13.0%
12.5%
12.0%
11.5%
2004
2005
2006
2007E
Source: Company reports and JPMorgan estimates.
The effect of the air commission reduction can be seen by viewing trends in domestic
revenue growth vs. gross bookings growth at the top 4 online travel agents. Note that
in 2006 and 2007E, revenue as a percent of gross bookings declined 40 bps each
year. For F’08E, we are modeling more flattish revenue as a percent of gross
bookings.
Preserving Market Share Will be Key
The domestic online travel market is entering maturity with the percent of bookings
online expected to increase only 30 bps in 2008. As a result, domestic online travel
growth should only slightly exceed the total travel market (6.6% Y/Y growth
expected for the travel market, vs. 9.5% estimated Y/Y online travel growth). With
this expected declining growth rate, market share would become key in determining
company sales increases.
48
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 23: Domestic Online Gross Bookings by Type
2008E
2006
Total
OTA
OTA
Gross
Gross
NonOTA
Bookings
Bookings
Non-
42%
58%
40%
OTA
Gross
Bookings
Total
Gross
Bookings
60%
Source: PhoCusWright, Company Reports, and JPMorgan estimates
We believe that online travel agents will continue to lose market share to hotel and
airline suppliers. As a result we are modeling OTA gross bookings growth of 7.8%
in F’08, slightly below the estimated 9.5% Y/Y growth for the online travel industry.
We expect suppliers and other non-OTA sellers to grow 10.7% Y/Y in F’08.
Our Proprietary Research Results
Price is King in Booking Decisions
The JPMorgan Internet Team completed a survey of over 1,200 U.S. residents in
November to determine Internet usage behavior. We discovered that, of the
participants who book travel online, 81.9% listed price as the most important factor
in making booking decisions. 94% of participants who book travel online listed
price as the top 3 most important factors for deciding where to book travel. The
second most important criteria in booking decisions was the number of hotel and
airline options available (57.7% of participants who book travel online listed this
option as one of their top 3 factors in deciding with whom to book travel). Least
important factors in online booking decisions were customer service and the
availability of a rewards program, which only 20.0% and 31.2% of participants who
book online selected as one of their top 3 factors in deciding where to book their
travel.
49
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 24: Most Important Factor in Determining Where to Book Online Travel
% of participants who book travel online
7% 3%
2%
2%
4%
82%
price
# of hotel/airline options
av ailability of a rew ards program
customer serv ice
ease of use
customer rev iew s
Source: JPMorgan research
Online Travel Sites are Used Extensively for Research Purposes
61% of respondents visit two or more travel websites to research prices and offerings
before booking a trip. Of participants who book travel online, Expedia appears to be
the most popular vendor with 37.8% of respondents having booked a trip through the
company in the last 12 months. Combined with participants who booked trips on
Hotels.com and Hotwire, 70.9% of participants who book trips online did so through
Expedia properties. Travelocity came in second with 26.5% of participants who
book trips online using them in the last 12 months. 23.0% of respondents who book
online used Orbitz in the last 12 months.
Figure 25: Percent of Online Booking Respondents Who Have Made a Purchase on Site in Last 12
Months
Other
Yahoo! Trav el
Trav elzoo
Trav elocity
Priceline
Orbitz
Kay ak
Hotw ire
Hotels.com
Ex pedia
Cheap Tickets
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
Source: JPMorgan Research
We Still See Much Room for Growth in Online Travel
Surprisingly, over half of our respondents (55.1%) book less than 25% of their travel
online. In fact, 34.6% of respondents do not book any of their travel online. Only
26.8% of respondents booked more than 75% of their travel online. We believe that
this demonstrates additional room for growth for online travel companies from
customers migrating online from offline sources in the U.S.
50
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
However, our thesis that suppliers pose a threat to online travel agent market share
seems to have been supported by our survey results. Of respondents who book trips
online, 39.9% of respondents stated that they preferred to book flights directly from
the airline while 45.3% of respondents stated that they preferred to book rooms
directly from the hotel of their choice. 25% of respondents booking flights online
and 23% of respondents booking hotels online stated that they had no preference in
where they booked their trips. Given the stated priorities of our participants, we
believe that pricing differences will be a key driver in their decision of where to book
their trip. Package offerings do not appear to attract purchases with 38.1% of
respondents who book online stating that they prefer to book hotel and air travel
separately and 31.9% of respondents have no preference.
International Expansion Integral to OTA Growth
We expect this theme from 2007 to continue into 2008. As a result of GDS
commission reductions and increased competitive pressure from suppliers on the
domestic front, we believe that movement into international markets is critical to the
success of OTAs in driving both top-line and bottom-line growth. We believe that
international markets yield revenue as a percent of gross bookings margins almost
double those of the US because the OTA services are more valued by suppliers
abroad who find it difficult to market their inventory in multiple languages across
Europe and Asia. Furthermore, we believe that international suppliers are less of a
threat to OTAs as they tend to be smaller independent hotels that would have a
difficult time achieving the scale necessary to move online booking in house.
Europe is Starting to Mature; Companies Establish an Asia Presence
While still a high-growth area, European online bookings growth is beginning to
slow as the market enters maturity. For F’08 we are projecting online bookings
growth of 18.2% (vs. 20.0% in F'07) due to a 60 bp increase in online vs. offline
bookings and a 5.5% increase in total European travel spend. Asia markets have
become more attractive to OTAs. We are projecting F'08 Asia online bookings
growth of 35% to $43.6B. We expect that many OTAs will grow faster than the
market rates as they increase inventory on their sites, expand into new markets, and
make strategic international acquisitions.
Figure 26: 2007 Estimated European Market Share
Ex pedia
17%
Others
ebookers
40%
7%
Lastminute
(Trav elocity )
17%
Opodo
Priceline
9%
10%
Source: PhoCusWright, Company Reports, and JPMorgan estimates
51
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Rising Expenses Likely with Expansion and Market Share
Retention Efforts
Sales & Marketing Spend Necessary to Support Market Share Retention
We expect that sales and marketing expenses will increase as a percent of revenue as
(1) online travel agents invest more heavily in offline marketing mediums such as
TV and (2) as increased competition for online marketing inflates keyword pricing.
We expect this to be especially prevalent with companies focused on international
expansion as we believe online advertising is the key means of marketing.
Using Nielsen adRelevance data, we believe that ad spend on domestic graphical ads
increased approximately 48% over the last four quarters at the top four online travel
agencies. During the same period, we note that the average revenue increase at these
same four OTAs was only 10%.
Figure 27: Domestic Graphical Ad Spend vs. Revenue Growth at Top Four OTAs
millions
1,500
30
25
1,000
20
15
10
500
5
0
0
4Q05
1Q06
2Q06
3Q06
4Q06
Graphical Ad Spend
1Q07
2Q07
3Q07
Total Rev enue
Source: Nielsen//NetRatings and JPMorgan estimates
Expansion Efforts Likely to Be Supported by Technology Spend
We think that global expansion efforts will likely result in companies investing more
heavily in technology platforms to support growth. Additionally, companies may
enhance their website and offer additional customer features or services in order to
differentiate their product and grow market share. Orbitz Worldwide is in the
process of rolling out Project Austin, which will provide a single, global, centrally
managed platform. This should provide more scale for coding and consolidation of
supply operations, accounting, customer service, and data center operations. Expedia
has completed the first phase of a new platform that will allow the company to
leverage the daily warehouse and make improvements in terms of merchandising,
CRM, and segmentations. In 2008, the company plans to migrate different parts of
sites onto the new platform and to enhance the data warehouse. We expect
technology investment to be a theme in 2008.
52
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 33: Top Worldwide Travel Sites by Unique Visitors
thousands
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Total Internet : Total Audience
Travel
Expedia Inc
Travelport
Yahoo! Travel
Priceline.com Incorporated
Travel Ad Network
TUI Group
Travelocity
Vueling Airlines
ViaMichelin
Lastminute.com Sites
Southwest Airlines Co.
SNCF
InterContinental Hotels Group
Hilton Hotels
Deutsche Bahn
About.com Travel
Air France-KLM Group
MSN Travel
Kayak.com Network
Marriott
Aug-2007
791,338
301,118
62,427
28,038
24,901
19,743
11,561
14,384
13,313
8,782
13,178
14,770
9,104
6,191
7,408
6,991
5,563
5,996
5,452
4,589
6,662
7,094
Sep-2007
797,836
290,081
56,938
25,396
22,351
17,224
14,881
14,379
13,433
9,549
11,148
11,009
8,705
5,819
6,672
6,605
5,713
5,025
5,849
5,452
5,961
6,251
Oct-2007
804,546
293,713
56,228
25,525
23,223
16,571
15,344
14,214
13,263
10,432
10,052
9,972
9,419
7,381
6,765
6,670
6,649
6,563
6,519
6,422
6,268
6,264
Source: comScore and JPMorgan estimates
53
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Online Photo Market Outlook
Digital Camera Penetration Continues to Grow
Digital camera penetration continues to grow at a strong rate. We estimate that 73%
of American households now own a digital camera. This is up from IDC’s estimate
of 49% in 2005. We expect digital cameras to continue to increase penetration,
although at a slower rate and we are currently forecasting 81% penetration by 2010.
Figure 28: Increasing Digital Camera Penetration
100%
73%
80%
60%
81%
49%
40%
20%
0%
2005
2007
2010
Source: Shutterfly, IDC, InfoTrends, JPMorgan Internet Team 2007 Consumer Survey, JPMorgan estimates
In addition to increasing digital camera penetration, we believe there are several key
trends that will drive growth in the digital photo and online printing markets:
(1) Digital camera owners take more photographs
(2) Consumers purchase higher-quality digital cameras
(3) Consumers upload more photographs on the web
(4) Consumers seek more efficient and user-friendly photo printing
technologies
(5) Consumers will buy more personalized photo product, such as greeting
cards, photo books and calendars.
As there is no cost associated
with taking digital photographs,
people are more apt to point and
click with higher frequency.
54
People are taking more photographs and spending money
to develop them
From 2003 to 2005, the average number of pictures taken per month by a digital
camera owner nearly doubled. As there is no cost associated with taking digital
photographs (unwanted photographs can be deleted to free up storage space), people
are more apt to point and click with higher frequency (vs. the replacement and
processing cost associated with traditional film).. According to our 2007 Consumer
Survey, approximately 29% of digital camera users take more than 50 photographs in
a month. People are also spending to print their photos, with 35% having spent over
$50 in the past year developing their digital photos.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 29: Number of Pictures Taken by Digital Camera Users, per
Month
Figure 30: Money Spent Developing Digital Prints, during the Past
Year
%
101-125
3%
%
126 +
7%
0-25
48%
76-100
8%
50.0
41.7
40.0
30.0
23.4
14.1
20.0
51-75
7.5
10.0
11%
7.8
2.0
3.6
$100-
$125-
$150+
$124.99
$149.99
0.0
26-50
$0-$24.99
23%
$25-$49.99
$50-$74.99
$75-$99.99
Source: JPMorgan Internet Team 2007 Consumer Survey
Source: JPMorgan Internet Team 2007 Consumer Survey
People are buying higher-resolution cameras
Whereas, in 2005, cameras with resolutions of six megapixels (MP) or more
accounted for less than a quarter of manufacturers’ shipments, by 2008, estimates
indicate that 95% of units will have 6MP or greater. As camera quality improves
further, we believe home printing solutions will continue to become less attractive to
consumers, and commercial processes capable of presenting the quality of the digital
image captured by better cameras will continue to grow in popularity. Additionally,
as digital camera penetration grows, the devices will likely be in the hands of people
who are less technology savvy than the earlier adopters. We believe these users will
be attracted to commercial printing solutions, such as online photo providers and
local merchants, because of their ease of use.
Table 34: Digital Camera Shipments – Breakdown by Quality
Percent of
shipments
5MP or fewer
6MP or more
2005
75.7%
24.3%
2006E
40.5%
59.5%
2007E
18.0%
82.0%
2008E
14.0%
86.0%
2009E
10.0%
90.0%
2010E
5.0%
95.0%
Source: IDC, 2005, NPD, JPMorgan Estimates
Digital camera owners use online photo services for
sharing and storing photos
As broadband penetration continues to increase and online photo sharing becomes
more mainstream, we expect the percentage of consumers uploading their photos to
the Internet to increase. Additionally, we believe consumers will find online photo
storage an attractive backup option for their photographs as the quality of digital
cameras (and therefore photo quality and size) continues to increase. According to
our Consumer survey, 31% of users with a digital camera downloaded their photos to
an online photo service.
55
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 31: Percentage of Digital Camera Owners Who...
%
Order prints o nline - have
pho to s mailed
16.1%
Order prints o nline - pick
up at sto re
21.0%
Emails pho to s directly to
peo ple
47.1%
Do wnlo ad pho to s to an
o nline pho to service
31.0%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Source: JPMorgan Internet Team 2007 Consumer Survey
We expect more people to develop photos outside the
home
In addition to the old retail model of in-store drop-off and pickup, consumers also
have the option of printing photos at home or uploading photos to online photo
websites and ordering prints through the mail. As digital camera penetration
increases, we believe online services, whether providing in-store pickup or mail
order delivery, will prove to be the most convenient medium for people to store,
enhance, print, and share their photographs.
PMA Marketing Research
estimates indicate that by 2009
more than 70% of digital prints
produced in the US will be
printed outside the home.
Early on in the digital camera revolution, at-home printing was the printing format of
choice. However, over the last few years, the introduction of self service retail kiosks
and online photo websites has provided viable and less expensive alternatives. PMA
Marketing Research estimates indicate that by 2009 more than 70% of digital prints
produced in the US will be printed outside the home.
Figure 32: Digital Photo Printing Trends
Billions of prints
20
15
10
5
0
4.7
5.5
6.1
6.9
7.5
3.7
2.4
1.2
3.4
4.6
4.4
4.9
5.5
5.5
5.4
2005
2006
2007E
2008E
2009E
Home
Retail
Online
Source: PMA Marketing Research
Between 2004 and 2006, the percentage of people printing the photos they wanted to
save nearly doubled, from 19% to 36% (InfoTrends). In 2006, the online share of
total digital prints purchased was approximately 20.2% (including in-store pickup
orders placed online), up from 13.3% in 2005. We expect online market share to
continue to grow as more users share photos online.
56
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 33: Number of Images Saved & Printed vs. Just Saved
Billions
35
30
25
20
15
10
5
0
9.5
11.8
18.0
15.9
13.7
5.5
7.4
9.5
10.7
11.6
2005
2006
2007E
2008E
2009E
Images Sav ed & Printed
Images Sav ed, but Not Printed
Source: PMA Marketing Research
Photo products create growth opportunity for online photo
printers
We expect the personalized products category (personalized greeting cards, photo
books, etc.) to be an area of growth for online photo providers during the next couple
of years. Despite the strong trends we are seeing in digital camera penetration and the
increase in photos printed using online sources, personalized photo product
penetration remains low. According to our survey, only 11% of the respondents
purchased photo greeting cards and only 8.2% purchased photo books. We expect
penetration to improve during the next couple of years as users continue to shift to
online photo services and new products become available to customers. According to
PMA Marketing Research, spending on personalized photo products is expected to
increase to $1,240M in 2008 from $694M in 2006.
Figure 34: Low Penetration Leaves Room for Growth in Personalized
Photo Products
Figure 35: Growth in Spending on Photo Products/Gifts
%
$ in millions
12.0%
11.0%
10.0%
1,400
7.6%
8.0%
8.2%
1,240
1,200
7.5%
951
1,000
694
800
6.0%
462
600
4.0%
400
2.0%
270
200
0
0.0%
Photo Greeting Cards
Photo Calenders
Source: JPMorgan Internet Team 2007 Consumer Survey
Photo Books
Personalized T-shirts
2004
2005
2006
2007E
2008E
Source: PMA Marketing Research
57
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 Online Payment Outlook
2007 proved to be a strong year for online payment platforms. PayPal saw thirdquarter growth accelerate as the Merchant processing business saw particularly
strong growth, Amazon entered the payment foray with its Amazon Payment offering
and Google Checkout is still viable. Revolution Money is trying to revolutionize
money management with its new money transfer service and credit card offering. In
Latin America, Mercadolibre has seen strong growth in its payment business and is
rolling out direct payment features starting in Chile. We expect trends to remain
strong in 2008 helped by:
• Continued strength in global e-commerce growth, helped by increased global
broadband penetration.
• The growing acceptance of payment solutions on third-party platforms, including
travel sites.
• Increased P2P money transfers, driven by the growing remittance market and
increased micro-lending.
• Increased use of mobile money transfer platforms should help drive revenues for
those with a presence in the market, such as PayPal and Amazon Payment
(through its relationship with Textpayme).
• Increased fee generation as platforms look at adding deferred payment plan
options, which are particularly attractive in developing markets.
Key Highlights from 2007
This past year was a successful one for online payment companies. Both PayPal,
which benefited from strength in its Merchants business, and MercadoPago,
Mercadolibre’s Latin America Payment platform, saw growth accelerate in the third
quarter of 2007. Some key events in 2007:
• PayPal launched a toolbar features that allows users to shop at any site that
accepts MasterCard. The toolbar automatically populates the credit card
information with a randomly generated credit card number.
• Amazon launched its Amazon Payment service and now requires all third-party
sellers on its Marketplace and Auction platforms to offer it as a payment option.
• Steve Case entered the online payment business helping to fund Revolution
Money, an online payment portal and credit card company.
• MercadoPago launched a direct payment version and began offering services to
third-party sellers, beginning with a roll-out in Chili.
• Alipay began offering Chinese shoppers the ability to purchase merchandise from
overseas web sites.
Global e-commerce growth expected to remain strong
We expect online payment portals to benefit from strong e-commerce growth in 2008
in both the U.S. and global markets. While we expect the overall retail environment
58
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
in the U.S. to remain weak, we expect online retailers to benefit from the continued
shift of retail dollars online, driven by (1) increases in product selection, (2)
continued Y/Y online sales improvements for brick-and-mortar retailers and (3)
further improved efficiencies from site optimization. Our international forecast is
driven by (1) continued rises in online shopping penetration, especially Western
Europe, (2) continued investments by online retailers in broadening selection, (3)
improvements in shipping infrastructure, (4) improved payment systems and (5)
better fraud protection.
Table 35: JPMorgan Global E-commerce Projections
$ in millions
Global eCommerce Forecast
US
Europe
Asia
ROW
Total
2004
94,581
85,827
29,538
9,440
219,385
2005
114,991
112,139
39,685
13,216
280,031
2006
139,384
139,126
50,556
18,502
347,568
2007E
164,431
179,226
63,340
25,903
432,900
2008E
193,502
224,911
77,899
36,265
532,577
2009E
227,321
257,748
94,686
47,144
626,899
2010E
266,808
289,966
114,673
61,287
732,735
'07 - '10 CAGR
17.5%
17.4%
21.9%
33.3%
19.2%
Source: JPMorgan estimates.
Global remittance market is expected to grow 10.9% in 2008
Celent estimates that over $311B in 2007 was transferred in the global remittance
market, and global remittance is expected to grow at a 10.2% CAGR between 2000
and 2008. The mobile global population and the desire to send money back to family
have led to the strong growth in remittance. The United Nation estimates that about
3% of the world's population, or roughly 175M people, is migrant, with the stock of
immigrants to high-income countries growing at 3% per annum between 1980 and
2000.
With about 31% of the population in developing countries under the age of 14, vs.
14% in developed countries, global migration is expected to remain robust. The
World Bank highlights two drivers behind the expected strong migration trends
through 2025. They include:
1.
The labor force in high-income countries is expected to decline. The
World Bank expects the labor force in high-income countries to peak
near 500M in 2010, then fall to 475M by 2025. This would lead to 100
workers supporting 111 dependents, compared to less than 100 today.
As a result, there would be greater demand for workers in the labor
force.
2.
Developing countries can supply the needed labor. With a large
population under the age of 14, and higher birth rates, the developing
world is expected to supply 1B workers by 2025, many of whom would
migrate to higher-income countries to meet their labor demands.
These workers likely would continue to send money back to their country of origin.
According to the World Bank's base-case scenario, new migrant workers could earn
as much as $481B more in real (after-tax) income in high-income countries than they
would have if they stayed in the developing countries. A large portion of this excess
wealth would likely find its way back to the migrant worker's country of origin
through remittance channels.
59
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 36: Global Remittance Receive Trends
$ in billions
400
350
300
250
200
150
213
159
167
183
2000
2001
2002
233
256
281
311
345
100
50
0
2003
2004
2005E
2006E
2007E
2008E
Source: Celent
PayPal Remains the Dominant Player
According to our proprietary survey, 55% of online shoppers use PayPal, compared
to 6% who use Google Checkout and 7% who use Amazon Payment. While the
sample is small, 57% of those who used all three payment services preferred PayPal.
Credit cards remain the preferred method for online shoppers with 83% stating that
they use credit cards to make online purchases.
Table 36: Preferred Online Payment Providers for Users of PayPal, Google Checkout and Amazon
Payments
Services Used
PayPal, Checkout & Payments
PayPal and Checkout
PayPal and Payments
Checkout & Payments
Number of
Respondents
16
21
39
2
PayPal
9
16
30
-
Preferred Service
GOOG
AMZN
Checkout
Payments
2
3
4
8
2
Other
2
1
1
-
Source: JPMorgan Internet Team 2007 Consumer Survey
Note: Survey of 1,261 Internet Users
Figure 37: Payments Methods Used by Online Shoppers
% of respondents who stated they shop online
100.0%
83.5%
80.0%
54.8%
60.0%
40.0%
20.0%
6.2%
7.0%
5.8%
0.0%
Credit Card
Pay Pal
Source: JPMorgan Internet Team 2007 Consumer Survey
60
Google Checkout Amazon Pay ment
Other
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Online Payment Providers Offer a Viable Alternative to
Other Payment Options
Users are still driven to online payment options despite strong satisfaction with
credit cards
PayPal, as well as Amazon Payment and Google Checkout, have been able to make
inroads into the online retail business despite 89% of online shoppers who use credit
cards rating their experience as either excellent or very good. Users of online
payment services also seem to be content with credit cards with 92% of PayPal and
Amazon Users rating their experience with credit cards as either excellent or very
good and 91% of Google Checkout users experiencing the same level of
contentment.
Figure 38: Online Shoppers' Satisfaction with Credit Cards for Users of Online Payment Services
% of online shoppers who use the selected payment option
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
65.9%
61.9%
50.1%
41.7%
47.6%
41.0%
25.0%
10.1%
1.3%
Pay Pal
Ex cellent
9.1%
0.0%
4.8%
3.2%
Google Checkout
Amazon Pay ment
7.5%
0.7%
Ov erall
Very Good
30.2%
Satisfactory
Needs Improv ement
Source: JPMorgan Internet Team 2007 Consumer Survey
Given the high level of satisfaction with credit cards, we find it remarkable that
penetration of online payment services is so high. We believe that the online payment
services offer users security and ease of use advantages over credit cards, including
eliminating the need to enter credit card numbers. Extending beyond e-commerce
shoppers, online retailers can benefit from lower total transaction costs and P2P users
benefit from lower costs and the added security benefit from not having to share
personal financial information, such as bank account numbers.
Figure 39: Online Payment Providers Simplify the Payment Process
Traditional payment structure
Merchant
Consumer
Payment
gateway
provider
Card issuer
processor
Merchant
bank
Card-issuing
bank
PayPal payment structure
Merchant
Consumer
Merchant
bank
Consumer
bank
Source: JPMorgan.
61
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
The young and wealthy are more likely to use online
payment providers
According to our proprietary survey, higher-income online shoppers, those earning
more than $75K per year, are more likely to use both credit cards and online payment
options. Almost 15% of those earning less than $25K/year selected “other” as the
preferred choice, with most people in that group using money orders.
Figure 40: Online Payment Option Use by Income
% of respondents who stated they shop online
100.0%
88.5%
81.8%
80.0%
60.0%
55.2%
54.6%
40.0%
11.5% 10.0%
4.3% 6.0% 7.4%
20.0%
1.1%
0.0%
Less than $75K
Credit Cards
More than $75K
Pay Pal
Google
Amazon
Other
Source: JPMorgan Internet Team 2007 Consumer Survey
Younger users, those between 18 and 33 years old, were the most likely to use online
payment methods, with 64% stating they use online payment services. However,
usage by 34 to 49 year olds was also strong, at 61%, and 60% said they used PayPal,
more than any other age group. Only 47% of those over 50 years old used online
payment services, with 88% stating they used credit cards, higher than any other age
group. We expect usage of online payment services to increase as younger people
age and move to higher-earning income brackets.
Figure 41: Online Payment Option Use by Age Group
% of respondents who stated they shop online
100.0%
80.0%
60.0%
40.0%
20.0%
0.0%
Credit Cards
Pay Pal
Google Checkout Amazon Pay ment
18-33
34-49
Other
50+
Source: JPMorgan Internet Team 2007 Consumer Survey
Key Features of Current U.S. Online Payment Providers
PayPal
PayPal expanded its availability in 2007 to include airlines such as Southwest and
Northwest, and is offered by thousands of merchants around the world. PayPal offers
62
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
a money market account for deposits, financing options and P2P money transfers.
While a majority of PayPal's volume still takes place on eBay's site, its Merchant
business is growing at a faster rate. We expect 2008 to be another strong year for
PayPal as it grows its international and Merchants business and are forecasting
transaction volume to increase 24.2% Y/Y to $61.36B.
Table 37: PayPal Fee Structure
Description
Fee for a buyer to make a purchase
Free
Fees for specific actions
Open an Account
Send Money
Withdraw Funds
Free
Free
Free for bank accounts in the US
Free
Free
Free for bank accounts in the
US
Free
Free
Free
1.9% to 2.9% + $0.30 USD
4.9% + $0.30 USD (limit of 5
transactions per 12 month period)
for domestic or U.S. transactions
1.9% to 2.9% + $0.30 USD
Add Funds
Receive payments funded by PayPal
Balance, PayPal Instant Transfer or PayPal
eCheck
Receive payments funded by Credit Card,
Debit Card or Buyer Credit
Personal Account
Premier/Business Account
2% + applicable Fees for cross
border payments
4.9% plus $0.30 USD for card
payments received using PayPal
on Skype
Exchange rate includes a 2.5% fee
Multiple Currency Transactions
Exchange rate includes a 2.5%
fee
Source: www.paypal.com
Amazon Payments
Amazon rolled out its Amazon Payments Service in 2007 and now requires all thirdparty sellers on its Marketplace and Auctions platform to offer it as a payment
option. Amazon Payments offers P2P money transfer options and has teamed up with
Textpayme to offer mobile services. Amazon Payments is also integrated with
Amazon Web Services to help developers create e-commerce sites.
Table 38: Amazon Payments Fees
Fees to send payments
Sending Payments
Fees to receive payments (by
payment method)
Bank Account
Credit Card
International Credit Card
Amazon Payments stored
funds
Fees
No fees
less than $0.05
2% of T V + $0.05
5% of T V + $0.05
6% of T V + $0.05
20% of T V, minimum fee of
$0.0025
$0.05 to $9.99
$10.00 and more
2% of T V + $0.05
5% of T V + $0.05
6% of T V + $0.05
1.5% of T V +
$0.01
2% of T V + $0.05
2.9% of T V + $0.30
3.9% of T V + $0.30
1.5% of T V + $0.01
Source: payments.amazon.com
Google Checkout
Google Checkout is now available on hundreds of Internet retail sites. Google
Adwords advertisers are offered discounted processing rates. Google Checkout does
not currently offer P2P money transfer services.
63
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 39: Google Checkout Fees
Description
Fees to use Google Checkout to process sales
Fee
2% + $0.20 per transaction.
AdWords advertisers, will also be eligible for free transaction
processing for some or all of the Google Checkout sales
each month.
For every $1 spend on AdWords each month,
advertiser can process $10 in sales the following
month for free through Google Checkout.
Source: www.google.com
Revolution Money
Revolution Money was started in 2007 and offers a low fee credit card, Revolution
Card, and a P2P money transfer platform, RevolutionMoney Exchange.
Table 40: Revolution Money Fees
RevolutionCard
RevolutionMoney
Exchange
Transaction Description
FEE
Integrates credit, stored value, prepaid and loyalty card
NO interchange fees
functionality.
Cardholders can activate RevolutionMoneyExchange functionality to their card
account, which allows users to transfer money to other customers for free*.
Cost to Accept RevolutionCard
RevolutionCard only
charges 0.50% (50 bps) of
the transaction value per
transaction for processing.
Where is it accepted
Currently being rolled out
in the US, not available
internationally
Account registration
Free
Register for an Account
Add Money electronically from Bank Account
Send Money
Receive Money
Request Money
Withdraw Money electronically to Bank Account
Withdraw Money by Check
Paper Statement
Returned ACH Fee
Overdraft Fee
Stop Payment on a Check
Source: www.revolutionmoney.com
64
Free
Free
Free
Free
Free
Free
$2.50 per check
$5.00 per statement
$35.00 per returned ACH
$35.00 per overdraft
$20.00 per check
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 Social Networks Primer
Key Takeaways
•
Runaway growth continued in 2007. Of the major sites, Facebook posted
the most impressive growth, with user minutes worldwide multiplying more
than six-fold, according to comScore data.
•
Not a fad – a technology that solves users’ problems. 2007 showed even
the strongest doubters that there is very strong demand by users for the kind
of interaction offered by social networks. We believe the sites’ gains in
usage share, partly at the expense of email sites, demonstrate user needs are
being better met.
•
One question for ’08: Will older users sign up? Our proprietary survey
indicates 70% of users aged 18-41 use social network sites, and only 22%
among those aged 42 or older.
•
Privacy concerns overstated. Internet users have consistently
demonstrated a willingness to trade information for features they find
useful. So long as sites do not overreach, we expect this trend to continue,
with yesterday’s outrage becoming tomorrow’s hot feature (please see p. 68
for a more nuanced discussion).
Growth still very strong in 2007
The growth of social networks in 2007 was very strong, with Facebook in particular
really coming into its own. For the three months ended October, US unique users to
Facebook’s site were up 125% Y/Y, while time spent on the site rose 157%. By
October, 18% of all US Internet users visited Facebook, compared to less than 9% a
year prior. Facebook’s 18% penetration remained a far cry from MySpace, which
saw almost 40% of US Internet users visit its site that month.
Globally, the growth picture is even more drastic. In terms of growth in users
worldwide, Facebook paced the competition with a 397% Y/Y growth rate.
MySpace, Orkut, Bebo, Friendster and Hi5 all grew their unique users at least 35%
Y/Y.
Table 41: Social Networks users are growing fast, and user time is growing even faster
Y/Y growth in August-October ’07 vs ’06; six largest sites worldwide in terms of minutes spent
Myspace
Facebook
Orkut
Friendster
Bebo
Hi5
Worldwide
Users, Y/Y
Minutes, Y/Y
36%
33%
397%
558%
57%
65%
75%
160%
135%
276%
43%
187%
Users, Y/Y
25%
125%
66%
56%
85%
4%
US
Minutes, Y/Y
17%
157%
95%
359%
198%
76%
Source: comScore Networks, JPMorgan estimates
65
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Meet the big six
Based on minutes spent in the second half of the year (as measured by comScore),
the following six sites are the largest social networking sites in the world:
•
MySpace. Launched August 2003, the site was acquired by News
Corporation in July 2005. MySpace’s user base tends to tilt somewhat
toward teens, and is more US-based than the audience for any of the other
big six. Also popular with musicians and bands.
•
Facebook. Launched February 2004, the site remains independent but in
October 2007, drew a $240M investment from Microsoft, which acquired a
1.6% equity stake. Microsoft also sells ads on Facebook. The site became
open to non-academic users in September 2006.
•
Orkut. Launched by Google in January 2004. The site has not taken off
significantly in the US, but is quite popular in Brazil as well as India and
Pakistan.
•
Friendster. Launched March 2003. In the US, the site has faded somewhat
after being an early leader in the space, but it remains quite popular in
Southeast Asia.
•
Bebo. Launched January 2005. The site is popular in the UK and other
English-speaking countries, including Ireland, as well as in Poland. In
4Q’07, announced a partnership with AOL for integration of instantmessenger software.
•
Hi5. Launched 2003. The site, though based out of the San Francisco Bay
Area, maintains a base of popularity in Latin America, as well as some
Asian countries.
Technology that fits a customer need
We think much of the success of social networks is attributable, at heart, to the fact
that they provide a superior technology for filling users’ social needs more
efficiently. In our 2007 Consumer survey, over 80% of social network users
indicated that they use the sites to keep in touch with friends.
Table 42: Users overwhelmingly lean on social networks to keep in touch
% among users of social network sites; respondents could choose multiple answers
Function
Keep in touch with friends
Reconnect with old friends
Share photographs
Meet new people with similar interests
Share Music/Find new music
To plan social events
Play games
Career networking
% choosing
80.1%
47.7%
36.8%
34.7%
17.8%
17.5%
11.6%
9.0%
Source: JPMorgan Internet Team 2007 Consumer Survey
When it comes to filling this user need, we believe social networks have two key
competitive advantages over alternative methods of keeping in touch:
66
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
•
News feeds. A news feed is a feature that enables users to see updates on
their friends’ lives, and vice versa, without needing to specifically contact
each other. As any social network user updates his/her profile, those updates
become visible to that user’s circle of friends.
•
Built-in spam filter. The promise of email is that anyone can contact you,
and that has also become its curse. Many proposed spam solutions have
focused on attempting to verify that the person contacting you is a friend,
but social networks have a built-in verification system that allows one to
ensure that the bulk of communication is from confirmed friends.
We think it is not coincidental that, at the same time that social networks have shown
significant Y/Y usage growth, the number of minutes users devote to email has
declined:
Table 43: comScore data indicates user time spent on email sites is declining Y/Y
Minutes of usage in millions
Yahoo! Mail
Windows Live Hotmail
AOL Email
Google Gmail
All email sites
Aug-Oct '06
47,132
32,862
13,150
4,179
113,241
Worldwide
Aug-Oct '07
44,230
28,739
12,488
7,494
106,144
Y/Y
-6%
-13%
-5%
79%
-6%
Aug-Oct '06
23,651
10,290
12,208
1,084
50,082
US
Aug-Oct '07
20,828
8,786
11,796
2,136
46,481
Y/Y
-12%
-15%
-3%
97%
-7%
Source: comScore Networks, JPMorgan estimates
High User Engagement
Social network sites excel in their ability to keep users on the site: comScore data
indicates that, on the six biggest social networking sites in the world, users spend an
average of 7 minutes per day, a number that has grown Y/Y.
Figure 42: Average time per user is growing on social networking sites even as it shrinks for
email
Average minutes spent on site, per user per day
10.0
8.0
7.7
6.1
6.5
7.2
6.0
4.0
2.0
0.0
Aug-Oct '06
All email sites
Aug-Oct '07
Top six social netw orks
Source: comScore Networks, JPMorgan estimates
Survey results: older users remain on the sidelines
Our November 2007 proprietary survey of consumers’ Internet usage patterns
reinforced the idea that social networking sites remain primarily the province of
younger users. 89% of users aged 18-25 reported that they visited a social
67
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
networking site at least once a month, while less than a quarter of users 42 or older
went to such sites.
Figure 43: Younger users more likely to visit social network sites
% of users, in each age group, that reported visiting a social networking site at least once per month
100%
89%
74%
80%
53%
60%
40%
25%
20%
20%
0%
18-25
26-33
34-41
Age
42-49
50+
Source: JPMorgan Internet Team 2007 Consumer Survey
Further, we would note that our survey did not include users younger than 18, an age
group that, on the whole, tends to be a very heavy user of social networking sites.
Privacy concerns overblown
Many social networking sites, especially Facebook, have faced public criticism for
their use of user information. Whether or not these criticisms have merit, from an
operational standpoint we believe concerns about privacy are unlikely to hamper the
growth of sites. We think history suggests that users are willing to give up
incremental information in exchange for features they find useful.
Additionally, we think the history of the rollout of news feeds on Facebook is
extremely instructive: In September 2006, when the feature was first introduced, it
was met with an uproar from users who cited concerns about privacy. In response,
Facebook emphasized that users have the ability to opt out of the feature. A year
later, the news feed is one of the central aspects of the Facebook interface, and other
sites, including MySpace and LinkedIn, have added similar features.
We believe such flare-ups are likely to re-occur. Nevertheless, we believe the track
record of social sites’ development suggests users have a strong desire for expression
and for an avenue to share what is going on in their lives – and the desire to share is
stronger than the desire to hide. Features that meet users’ need for expression are
likely to catch on, in our opinion, even if they carry with them an incremental erosion
of users’ privacy.
Eventually, the CPMs will move up
Social networking sites, as a general rule, have not been able to command very high
advertising rates for their page view inventory. Indeed, we believe the arrival of a
significant quantity of bulk page-view inventory from social networks contributed to
stagnant graphical ad CPMs for much of the last years.
As time goes on, however, we believe social networks will develop better targeting
and monetization of their page view inventory. Given the wealth of personalized
68
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
information available to the sites, there are powerful avenues for improved
monetization, although the technology remains fairly nascent.
Large Internet and media companies have not been shy about making their presence
felt in the social space, both through acquisitions and through advertising deals, such
as Google’s $900M partnership with MySpace and Microsoft’s relationship and
small ownership stake in Facebook.
Table 44: Large Internet Companies’ Investments in and Partnerships with Social Sites
Date
January, 2004
3/12/2005
5/18/2005
Acquirer
Google
Yahoo! Inc
Google
Target
Launch of Orkut
Ludicorp Research, the owner of Flickr ($40M)
Dodgeball
6/20/2005
7/19/2005
8/7/2006
8/23/2006
11/17/2006
12/20/2006
12/30/2006
1/9/2007
2/27/2007
2/27/2007
5/30/2007
6/1/2007
8/1/2007
9/14/2007
9/28/2007
10/4/2007
10/7/2007
10/9/2007
10/24/2007
Yahoo! Inc
News Corp
Google
Microsoft
Yahoo! Inc
IAC/ Interactive corp
Yahoo! Inc
Yahoo! Inc
IAC/ Interactive corp
IAC/ Interactive corp
eBay
Google
Disney
Yahoo! Inc
Google
Time Waner
GE and Microsoft
Google
Microsoft
Yahoo! acquires Blo.gs.
Intermix (including MySpace) ($580M)
Fox Interactive Media Enters Into Agreement with Google Inc.
Microsoft Signs Agreement to Show Ads on Facebook
Bix.com
Ilike.com
del.icio.us
Mybloglog
Edodo.Com
Netclub
Stumbleupon Inc ($75M)
Feedburner Inc
ClubPenguin ($350M)
Buzztracker.Com
Zingku
AOL’s AIM and Bebo to offer seamless integration
Newsvine Inc (acquired by MSNBC Interactive News)
Jaiku Ltd
Facebook (Microsoft acquired a 1.6% stake for $240M)
Description
Social Network site
Photo-sharing site
A social networking software provider for mobile
devices.
RSS aggregator
Social Network site
Advertising deal
Advertising deal
Interactive contests
Music sharing for SN sites
Website sharing
blog communities service
Dating site in China
Dating site in France
Website sharing
RSS feed distribution.
Virtual world
Popularity-based news
Photo sharing for mobile phones
A global partnership to deliver AIM to Bebo users
Popularity-based news
Social Networking software for mobile phones
Source: Company reports, news reports
69
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
2008 Virtual Online Worlds Primer
Key Takeaways
•
The market is in its infancy, so ’08 should bring continued rapid
growth. Due to increased awareness, continued product innovation, and
faster Internet connections, we think the short-term portends significant
usage growth for virtual worlds.
•
We are bullish on sites for children. Virtual worlds present parents an
opportunity to let their kids play online and interact in a closed environment
that is perceived as safe, especially when sites are operated by companies
with trusted brands.
•
We think sites aimed at adults have yet to prove mainstream appeal.
Adults have much more freedom than children to choose other avenues of
social interaction. As such, while short-term growth should remain robust,
we think that, in their current form, virtual worlds aimed at adults are
unproven in their ability to achieve meaningful mainstream penetration over
the long term.
Two Audiences, Two Differing Growth Curves
With investments by major media companies, virtual worlds have been making news
for several years. Most recently, Disney purchased Club Penguin in July ’07 for as
much as $700M, and throughout the year there has been a steady flow of news
stories, both positive and negative, regarding virtual world sites, primarily Second
Life.
We believe that virtual worlds are still in the very early stage of their growth, and as
such have the capacity to grow very rapidly in the near future. However, we think the
market is ultimately one that should be seen as consisting of two parts – virtual
worlds for children, and ones for adults– with diverging longer-term growth
prospects.
We think virtual worlds for kids are a product with strong promise, and one that
could achieve mainstream status in coming years. To the contrary, we think that
virtual worlds aimed at adults face greater challenges. We think it is telling that
virtual worlds have proven successful among kids, who have limited social options,
and in places such as Finland, where external factors such as climate may limit users’
offline social options.
As such, we think the ability of virtual worlds (as distinct from video games, which
target a different, more male demographic) to achieve mainstream penetration has
not yet been proven.
70
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 44: In the US, virtual worlds for kids have a much bigger audience
Average monthly US unique users in millions, Aug-Oct '07
7.0
6.1
6.0
Virtual Worlds for kids
5.0
5.0
Virtual Worlds for Adults
4.3
4.0
3.0
2.0
2.0
0.5
1.0
0.0
WebKinz
ClubPenguin
Neopets
IMVU
SecondLife
Source: comScore Networks, JPMorgan estimates
Some Terms, Defined
What is a Virtual World? Two other definitions are important:
•
Social Network: a site that allows users to form connections with others.
Sites that are considered social networks will generally consist of profiles
intended to represent the user more or less faithfully. Examples: MySpace,
Facebook.
•
MMORPG: (stands for Massively Multiplayer Online Role Playing Game)
a game that creates an opportunity for users to interact with each other and
with an immersive game environment. Prominent examples: World of
Warcraft, EverQuest.
•
Virtual world: these sites straddle a middle ground between social
networks and MMORPGs, offering social functions in an immersive world.
Some examples of virtual worlds include Second Life, Gaia Online,
ClubPenguin and Neopets.
A virtual world creates an immersive environment for users to interact with each
other, but the emphasis is not chiefly on gameplay, as in a MMORPG. Rather, the
focus is on interaction with other users in a social way, and often on personalizing a
user’s VW presence, called an avatar, or personalizing the avatar’s surroundings and
possessions.
How Do They Make Money?
Most virtual worlds operate on one, or a combination, of three models: advertising,
subscription revenue and the sale of virtual goods – whether virtual currency to be
used inside the world, or improvements to a user’s avatar. As the worlds mature,
especially in those aimed at adults, advertising may play a larger role, although we
think the exact look and feel of VW ads will likely change before we see a significant
influx of revenue from external advertisers.
71
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Challenges to an advertising-supported virtual world model:
•
Kids and pre-teens a key market. Although some children’s sites have
used sponsorships and ads as a revenue stream, we believe parents who
oversee their kids’ browsing may be leery of strongly commercial sites,
especially for younger kids.
•
Hard to control environment. The free nature of many virtual worlds
means many sites have adult content that mainstream advertisers may not be
comfortable appearing next to.
•
Issues of scale. Some companies have set up a presence on Virtual Worlds,
esp. Second Life, that must be continuously overseen by an employee
whose avatar interacts with visitors. The investment of time may not pay off
if traffic is too low, and such a presence does not scale well.
•
High site engagement. If users are highly immersed in an online
environment, their lower response to call-to-action advertisements is
unlikely to generate attractive CPMs.
Virtual Worlds for Kids and Teens
Audience Is Growing
eMarketer estimates that nearly 4 out of 5 US teens will be online in 2008, and
projects a 25% 2007-2011 CAGR in the number of kids aged 3-17 visiting virtual
world sites.
Figure 45: More than half of kids expected to visit Virtual Worlds in 2011
Users in millions
25
60%
20
50%
40%
15
30%
10
20%
5
10%
0%
0
2006
2007
2008
Kids 3-17 Visiting VW sites
2009
2010
2011
% of Kids 3-17 Visiting VW sites
Source: eMarketer, September 2007
We believe there is considerable cause for optimism in terms of kids’ adoption of
these sites, for several reasons.
Captive Audience
One key reason, and a differentiating factor between kids’ worlds and ones for
adults, is that kids’ entertainment options are severely constrained, compared to those
of adults. The successful kids’ sites are those that can give children a degree of
freedom and interactivity, while assuring parents that their kids are in a safe
environment.
72
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Major Media Brands Are Investing
Two major media companies, Walt Disney and Viacom, have made significant
investments in the Virtual World space, exemplified most recently by Disney’s
purchase of Club Penguin.
Table 45: Major Media Companies' Forays into VW space
Company
The Walt Disney Co.
Viacom
Date
June '03
July '07
June '05
Jan. '07
Event
Launched Toontown Online
Acquired ClubPenguin for $700M ($350M + $350M earnout)
Acquired NeoPets for $160M
Launched Nicktropolis
Source: Company releases
In the area of trust, we think the big media companies have an advantage, with
established brands that parents are already familiar with. At the same time, any site
aimed at kids is going to be subject to the whims of a fickle audience. As such, we
think media companies are likely to remain open to acquiring sites that generate
significant viral traffic.
Table 46: Summary of Virtual Worlds Aimed at Kids and Teens
Site
Owner
BarbieGirls
Mattel
ClubPenguin
CyWorld
Disney
SK
Telecom
Private
Gaia Online
Target
Audience
Young Girls
Kids
Teens, 20's
Pre-teens
and teens
Teens
Habbo Hotel
Sulake
(Finland)
Millsberry
NeoPets
General
Mills
Viacom
Kids
Webkinz
Whyville
GANZ
Private
Kids
Kids
Kids
Business
Model
Toy Sales,
Subscriptions
Subscriptions
Virtual Goods
Virtual Goods,
ads
Ads and
Virtual
Currency
Product
Promotion
Premium
Memb., Ads,
Virtual Items
Toy Sales
Ads
Geographic
Base
US, WW
Aug-Oct ’07 avg.
monthly UU
3.4M
Y/Y User
Growth
N/A
US, WW
Chiefly: Korea
10.3M
14.8M
152%
N/A
US, WW
2.0M
195%
Europe, WW
6.3M
23%
US
2.4M
11%
WW
7.5M
20%
US
US
5.9M
0.1M
545%
22%
Source: Company sites, comScore Networks, JPMorgan Estimates
User statistics are based on worldwide usage as tracked by comScore.
Virtual Worlds for Adults
Whereas virtual world sites aimed at children are starting to gain significant traction,
the marketplace of sites aimed at adults remains in a much earlier phase of
development. E.g., Second Life, often touted as representative of the mainstreaming
of virtual worlds, had 0.2% penetration of US Internet users in 10/07, according to
comScore data. As such, the site could grow traffic five-fold or even ten-fold and still
retain a somewhat limited reach.
73
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 47: Summary of Virtual Worlds Aimed at Adults
Site
Business Model
Geographic Base
ActiveWorlds
IMVU
Kaneva
SecondLife
Subscriptions, Hosting
Premium Accounts, Ads
Ads, Virtual Currency
Subscriptions, Virtual
Goods and Virtual
Currency, Ads
Premium Accounts
US, WW
US, WW
70+% US
75% Outside US
There.com
Aug-Oct ’07 avg.
monthly UU
0.1M
4.9M
0.7M
2.3M
Y/Y User Growth
0.2M
0%
US, WW
181%
71%
365%
N/A
Source: Company sites, comScore Networks, JPMorgan Estimates
User statistics are based on worldwide usage as tracked by comScore.
Not Just a Toy for Men
Virtual worlds’ interactivity and social aspect differentiates them from MMORPGs
such as World of Warcraft, both in terms of usage and in terms of the demographics
they attract. And while Second Life seems to attract more male users, a site like
IMVU, with its focus on the social aspect, actually has a higher percentage of users
who are female, according to comScore metrics.
Figure 46: While Warcraft attracts men, a site like IMVU tilts female.
100%
80%
26%
38%
54%
50%
46%
50%
IMVU
My Space
60%
40%
74%
20%
62%
0%
World of Warcraft
Second Life
Male
Female
Source: comScore Networks, JPMorgan estimates
comScore data for October 2007, Worldwide user base. Warcraft and Second Life based on application users.
Challenges
Second Life, in particular, has generated a significant amount of publicity over the
past year, both positive and negative. The site has been very aggressive in signing up
corporate sponsors, with companies such as IBM, Cisco, Toyota, Mazda and dozens
of others setting up a presence in the world.
The site has also generated negative attention due to gambling (banned after an FBI
investigation) and adult content. While we do not believe these issues present an
existential threat, we think they are unlikely to go away, as world designers must
navigate a narrow path between a total free-for-all and a site where usage regulations
become too restrictive, significantly affecting the site experience and user growth.
74
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
The Mobile Ad Market
One-third of the World’s Population Are Mobile Subscribers
The mobile market is a large and quickly growing industry with an estimated 2.2B
mobile subscribers worldwide growing at an estimated pace of 23% Y/Y. Given this
level of reach, we think this medium would be attractive to advertisers. A quick
comparison to broadband penetration demonstrates this point.
On a worldwide basis, 33% of
the population has mobile
subscriptions vs. 4% with
broadband subscriptions
¾
We estimate that 67% of Americans are mobile phone subscribers while
only 57% have broadband subscriptions.
¾
We believe that this disparity is even greater in developing countries. In
China, for example, our estimates indicate there are approximately 30%
mobile subscribers per 100 persons but only 4% broadband subscribers per
100 people.
¾
On a worldwide basis, 33% of the population has mobile subscriptions vs.
4% with broadband subscriptions.
In short, this medium offers advertising brands very large reach in marketing their
products. Please see Table 1 on the following page for a breakdown of subscription
rates by country.
Mobile Ads Offer Targeting and Relationship Capabilities
Traditional advertising forms offered limited targeting capabilities. Advertisers
would select specific television programs, newspaper sections, or magazines that
attracted a certain demographic and then hope that some of those viewers were
searching for their product. Targeting capabilities were much better with the
Internet. Search marketing offered the opportunity to pair an advertisement with a
person searching for information on that specific product. Display advertising is
improving so that ads can now be targeted to consumers based on previous sites they
have visited. In all cases, the ads were typically pushed onto the consumer.
Figure 47: Traditional Advertising Methods
Consumer Behavior: Watch The
Food Network
Advertiser Response: Show ad for
for general food products
Consumer Behavior: Search for wine
Advertiser Response: Show ad for
popular red wine brand
Source: JPMorgan
75
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 48: Mobile and Broadband Penetration by Country
millions
Country
Population (M)
Broadband Subs BB Subs per 100
Mobile Subs per
(M)
Persons
Mobile Subs (M) 100 Persons
Egypt
Morocco
South Africa
Africa
China
Hong Kong
India
Indonesia
Japan
Malaysia
Pakistan
Philippines
South Korea
Taiwan
Thailand
Vietnam
Asia Pacific
Austria
Belgium
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Italy
Netherlands
Norway
Poland
Portugal
Romania
Russia
Spain
Sweden
Switzerland
Turkey
Ukraine
United Kingdom
Europe
Iran
Israel
Middle East
Canada
Mexico
United States
North America
Australia
New Zealand
Oceania
Argentina
Brazil
Chile
Colombia
Peru
Venezuela
South America
71.4
30.7
47.6
914.3
1,323.7
7.1
1,119.7
225.5
128.2
25.8
157.0
84.5
48.0
22.8
64.8
85.3
3,693.0
8.2
10.4
10.2
5.4
5.3
60.7
82.7
11.1
10.1
58.1
16.3
4.6
38.5
10.5
21.6
142.5
43.4
9.1
7.3
74.2
46.0
59.8
813.1
69.1
6.4
190.0
32.4
108.3
299.7
439.0
20.4
4.0
33.2
39.1
188.9
16.5
46.3
28.4
27.2
461.8
0.1
0.3
0.2
2.9
47.0
1.5
2.0
0.5
24.2
0.7
0.1
0.1
12.8
4.4
0.3
0.3
99.6
1.5
2.0
1.0
1.6
1.3
11.1
12.4
0.3
0.8
8.0
4.7
1.1
2.0
1.4
0.4
2.1
5.9
2.1
2.0
2.1
0.1
11.6
72.4
NA
1.5
3.8
7.2
3.0
56.5
66.6
3.5
0.5
4.0
1.1
4.9
1.1
0.5
0.4
0.4
9.7
0.1
1.0
0.5
0.3
3.6
21.6
0.2
0.2
19.0
2.7
0.1
0.2
26.1
19.2
0.5
0.4
2.7
17.8
19.5
9.4
29.1
25.0
17.7
15.1
2.8
7.9
13.8
28.5
24.7
5.3
12.8
1.8
1.5
14.6
22.7
25.9
3.0
0.2
19.1
9.0
NA
23.5
2.0
21.5
2.7
18.8
15.2
17.3
11.7
11.8
2.7
2.6
6.8
1.1
1.5
1.6
2.6
13.6
16.0
39.7
193.8
461.1
9.4
166.1
63.8
101.7
19.5
34.5
42.9
40.2
23.2
40.8
15.5
1,073.3
9.3
9.7
12.1
5.8
5.7
51.7
84.3
11.1
10.0
71.5
15.8
5.0
36.7
12.2
17.4
150.0
46.2
9.6
7.4
52.7
49.1
69.7
797.6
13.7
8.4
63.6
17.0
57.0
201.7
275.7
19.8
3.5
24.1
31.5
99.9
12.5
29.8
8.5
18.8
282.3
19.1
52.1
83.3
21.2
34.8
131.5
14.8
28.3
79.3
75.5
22.0
50.8
83.8
102.0
63.0
18.2
29.1
112.8
92.6
119.0
107.3
107.8
85.1
101.9
99.6
99.0
123.1
97.2
108.6
95.5
116.0
80.5
105.2
106.4
105.9
102.1
71.0
106.7
116.4
98.1
19.4
122.7
33.5
52.5
52.6
67.3
62.8
97.0
87.6
72.6
80.5
52.9
75.6
64.3
30.0
69.0
61.1
World Wide
6,544.4
259.1
3.9
2,710.4
41.4
Source: CIA Government Stats (http://www.cia.gov/cia/publications/factbook/index.html), International Telecommunications Union
(http://www.itu.int/ITU-D/ict/statistics), JPMorgan estimates.
76
Imran Khan
(1-212) 622-6693
[email protected]
Multimedia and interactivity
create a relationship with the
customer.
North America Equity Research
02 January 2008
Mobile advertising has the potential to offer even more specific capabilities. Local
search advertising overlaid on map applications could become key as users want
information on the nearest restaurants, hotels, and entertainment. Application
providers will likely amass much user information as cell phone owners download
ringtones, games, and wallpaper, sign up for stock quotes and news headlines, and
participate in social networking activities.
Additionally, the ad format could move from a one-way message directed at the user
to an interactive multimedia means of communicating with potential customers.
Mobile advertising could eventually make use of the following tools:
¾
SMS
¾
Applications
¾
MMS
¾
Video
¾
Web
¾
Cell TV
¾
Search
¾
Broadcast TV
¾
Game
For example, a wine brand could create an interest group with a WAP site for
viewing recipes and wine pairings, wine tasting dates, making purchases, and
communicating with others connoisseurs.
Figure 48: Potential Mobile Ads for Customer Interested in Wine
Brands offer dinner music
ringtone downloads and recipes
with links to appropriate wine
pairings
Invite friends to join
club
Email questions
about wine and
food pairings
Wine store sends texts about
local wine tastings
Source: JPMorgan
77
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Can Mobile Ads Achieve the Internet Ad Growth Curve?
While Internet ad spend growth rates remain very strong, they have begun to stabilize
as the industry has become more established. Many Internet companies are now
looking for the next medium to sustain their top-line growth.
We are estimating an ~80% 4year CAGR with mobile
marketing spend reaching $13B
by 2011, putting it in what we
view as the very beginning
stages of the Internet ad growth
curve.
Strategy Analytics is forecasting that advertisers will spend $1.4B globally on mobile
media this year. If mobile advertising follows a similar trajectory to Internet
advertising, the medium could mean the next wave of growth to online ad
companies. We estimate that Internet advertising has grown at a 25% CAGR over
the past 5 years globally. Currently, we are estimating an ~80% 4-year CAGR with
mobile marketing spend reaching $13B by 2011, putting it in what we view as the
very beginning stages of the Internet ad growth curve.
Figure 49: Comparison of Global Search, Graphical, and Mobile Growth Curves
$ in millions
40000
35000
30000
25000
20000
15000
10000
5000
0
2001
2002
2003
2004
Search
2005
2006
2007E
Graphical
2008E
2009E
2010E
Mobile
Source: Company reports, JPMorgan estimates, Strategy Analytics, eMarketer, ComScore, Nielsen NetRatings, IDC, IWS, and IAB.
Table 49: A Comparison of Online and Mobile Advertising
Targeting
User Information
Format
Bandwidth
Standardization
Online Advertising
high targeting through search; less in
graphical and video ads
user information primarily obtained through
cookies
high text, video, and imaging capabilities
high bandwidth available
very standardized
Mobile Advertising
very targeted especially on a geographical
basis
great deal of user information direct from
customer
low formatting abilities given phone quality
low; dependent on carrier
dependent on phone and carrier
Source: JPMorgan research and company reports
Domestic Market Overview
While we believe the market is clearly attractive for its size, reach, targeting and
multimedia capabilities, monetization of the space will likely be more difficult than
the Internet. Following is a discussion of the key issues that we believe online
advertising companies will face as they try to gain share in the space.
Mobile Carrier Control
Having learned a lesson from watching Internet service providers miss benefiting
from online ads, we believe mobile operators will be careful to make sure that they
78
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
get a good slice of the mobile advertising pie. As a result of this, they have created a
somewhat “walled garden” in their mobile portals where operators have better
control over the flow of mobile ads and the revenue they generate.
Mobile carriers control what
software, services, and
applications will be available on
mobile phones.
Recently, we have seen Internet companies partner with operators in revenue sharing
agreements. For example, Yahoo! and Rogers Communications just announced a
partnership for Yahoo! to deliver their Go 2.0 and oneSearch products across
wireless customers in Canada. Another notable partnership was the iPhone
arrangement between Apple and AT&T. While AT&T allowed Apple to develop an
ongoing relationship with customers through its iTunes platform, AT&T was named
the exclusive domestic mobile provider of iPhones. We believe that more
partnerships will be developed but that mobile carrier control has somewhat hindered
mobile innovation due to the lack of scale developers can achieve.
Google has approached the control issue differently with its entry into the 700 MHz
spectrum auction. Partly as a result of Google's lobbying efforts, the FCC ruled that
the C Block of spectrum would be limited open access (open devices and open
applications) if a minimum bid of $4.6B was met. In December, Google officially
announced its intention to participate in the FCC auction scheduled to start January
24th. If Google is successful, it is in the position to operate a wireless network itself
or to help it build one and potentially resell wireless services.
Device and Network Capabilities
Until the advent of the iPhone, cellular devices were not well designed for web
browsing and messaging use. Small screen size prevented easy viewing. Small
keyboards demanding multiple taps to get the letter desired made messaging difficult.
Complex user-interfaces, small
screens, and slow loading
browsers have limited mobile
feature use.
Navigation to various features required multiple clicks and complexity for many
people. Slow-loading browsers and networks make mobile web navigation
reminiscent of PC capabilities over a decade ago. As a result of this, US uptake of
various features has been limited. In a survey by NPD Group, only 13% of
Americans had mobile access to their email, 12% had mobile Internet access, and
39% used text messaging features.
Figure 50: U.S. Mobile Feature Usage
100%
80%
60%
40%
20%
0%
Mobile email
Internet access from
Tex t Messaging
Instant Messaging
handset
Source: NPD Group and JPMorgan estimates
79
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
User Reaction
Consumers consider cell phones a highly personal device and it is not clear how they
would react to having advertisements delivered through it. Some advertisers may
fear reactions similar to those to email spam and telemarketer calls.
Consumers may have a negative
reaction to mobile advertising.
We believe that in order for advertisers to successfully use this medium, they must
deliver clear value to consumers. This could take many forms, including:
¾
Free or reduced-priced mobile service
¾
Additional services or applications provided by the advertiser
¾
Ads targeted to a specific and immediate need
¾
Opt-in/out features
Whatever the method, we believe advertisers must be sure not to alienate the
customer and his/her privacy in marketing endeavors.
International Markets Are More Attractive
While U.S. adoption of mobile
services outside of phone use
has been low, international
users have embraced the
technology.
80
The U.S. Trails International Markets in Mobile Services Adoption
While U.S. adoption of mobile services outside of phone use has been low,
international users have embraced the technology. In Japan, 85% of cellphone
owners have mobile email and 78% access the Internet from their handset. Over
66% of Japanese mobile phone owners use PDA functions on the device.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 51: Mobile Feature Use in Japan and the U.S.
Watch TV on Mobile Phone
Video Messaging
Instant Messaging
Digital Music Play er
Tex t messaging
Picture messaging
Play mobile games
Dow nload graphics/screensav ers
PDA functions
Dow nloading ringtones
Internet access from handset
Mobile email
0%
10%
20%
30%
40%
Japan
50%
60%
70%
80%
90%
US
Source: NPD Group and JPMorgan estimates
Although mobile feature usage in Europe is not as high as in Japan, Europeans, on
average, still outpace Americans in mobile feature usage. The two countries are
similar on SMS usage with 41% of Europeans using the technology vs. 39% of
Americans. However, there are vast differences in multimedia messaging and
mobile Internet access. In both cases, approximately 26% of Europeans use the
technologies while only 12% of their American counterparts do.
Table 50: Mobile Feature Usage in Europe
SMS
MMS
Mobile Internet
US
39%
12%
12%
Europe
41%
26%
26%
Source: NPD, Gartner G2, M: Metrics, Forrester, comScore, and JPMorgan estimates
So why are American consumers trailing in mobile adoption? It doesn’t appear to be
due to lack of interest. In a Pew Research Center survey, the company found that
47% of Americans would like to have mobile maps, 38% were interested in IM
services for their phone, and 24% wanted email access and search capabilities to find
movie listings, weather reports, and stock quotes. Media-Screen surveys found that
the reasons most cited for not using mobile Internet services were cost and
connectivity issues.
81
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 52: U.S. Survey Respondents Interested in Using the Following Mobile Services
50%
40%
30%
20%
10%
0%
Maps
IM
Search for
Email
Cameras
serv ices (mov ies,
etc)
Source: Pew Research Centers and JPMorgan estimates
International Advertisers Have Begun to Enter the Market
Due to these higher mobile services adoption levels, marketers have begun to
experiment with mobile advertising in the international market.
Surveys of 50 brand name
European companies revealed
that 89% of brands plan to use
text and multimedia messaging
to reach their audience by 2008.
Surveys by Airwide Solutions of 50 brand name European companies revealed that
89% of brands plan to use text and multimedia messaging to reach their audience by
2008. Of these, one-third plan to spend over 10% of their marketing budget on the
medium. In five years, 52% of the brands expect to spend between 5%-25% of their
total marketing budget on mobile marketing. Currently, 40% of the brands have
already initiated text messaging campaigns and 18% have launched MMS
campaigns.
Figure 53: Global Mobile Ad Spend Forecast for 2011
2% 2% 3%
1%
10%
1%
1%
32%
48%
SMS
MMS
Web
Search
Game
Application
Video
Cell TV
Bcast TV
Source: Strategy Analytics, eMarketer, and JPMorgan estimates
Challenges in the International Market
While the launch of mobile ad campaigns seems to have progressed further overseas
than domestically, it is not without its weaknesses. For mobile advertising to
maximize revenue streams, business models need to be established by carriers,
advertisers, and marketing companies. Issues such as opting in or opting out of text
advertisements and controlling the number of text ads received still need to be
determined. Finally, each country’s privacy laws must be taken into consideration to
determine how much information possessed by operators about their clients’ habits
can be shared with advertisers and marketers to target ads.
82
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Conclusions
Attractive market size and reach
The mobile market is a large and quickly growing industry with an estimated 2.2B
mobile subscribers worldwide growing at an estimated pace of 23% Y/Y. On a
worldwide basis, 33% of the population has mobile subscriptions vs. 4% with
broadband subscriptions. In short, this medium offers advertising brands a very large
reach in marketing their products.
Strong targeting and relationship building capabilities
Application providers will likely amass much user information as cell phone owners
download ringtones, games, and wallpaper, sign up for stock quotes and news
headlines, and participate in social networking activities. Additionally, the ad format
could move from a one-way message directed at the user to an interactive multimedia
means of communicating with potential customers including email, text messaging,
web pages, applications, search, and MMS.
Mobile ad growth could approximate that of the Internet
We estimate that Internet advertising has grown at a 25% CAGR over the past 5
years globally. Currently, Strategy Analytics and eMarketer are estimating an ~80%
4-year CAGR with mobile marketing spend reaching $13B by 2011, putting it in
what we view as the very beginning stages of the Internet ad growth curve.
Barriers to entry could slow domestic adoption
We believe that development of mobile ads has been inhibited primarily by three
factors. First, mobile carrier control seems to have limited Internet entrants who
need to make partnerships to have their services available on the phone. Second,
devices have poor user interfaces, high costs, and slow connectivity times. Finally,
users view their mobile phones as personal devices and reception to mobile
marketing may be cool.
International markets are in the early stages of development
Use of mobile services and features is greater in Europe and Japan than in the U.S.
As a result marketers have begun to test mobile advertising in these markets.
Surveys by Airwide Solutions of 50 brand name European companies revealed that
89% of brands plan to use text and multimedia messaging to reach their audience by
2008. Of these, one-third plan to spend over 10% of their marketing budget on the
medium.
Company Initiatives
Google Introduces Android
Google decided to address distribution difficulties head-on with the creation of the
Open Handset Alliance, composed of leading technology and wireless companies
committed to the development of an open platform for mobile devices. The Android
platform is a fully integrated mobile "software stack” consisting of an operating
system, middleware, user-friendly interface, and applications. The first phones based
on Android are expected to debut in the second half of 2008. By bringing the
Internet developer model to the mobile market, it is hoped that increased innovation
will make the phone features more attractive, affordable, and user-friendly for the
consumer.
83
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Despite speculation about the development of a Google Phone or GPhone, we
believe that it is unlikely that Google will choose to enter the hardware business.
First, none of Google’s core competencies lie in this business and it would take much
investment in technology, marketing, and people to ramp it up. Secondly, the
handset business is a much lower-margin business than online advertising. We
estimate that operating margins for handset makers range from 10%-20% and are
skewed toward the lower end of the range. In contrast to this, we believe that Google
will achieve an operating margin north of 50%.
Instead, we believe that it is more likely that Google will pursue methods to increase
the distribution of its products and services, so that they may later be monetized. If
the Android open platform is widely rolled out, more consumers would have access
to Google features. Google has introduced many mobile products, including search,
Gmail, YouTube, Picassa, maps, and GOOG-411. We believe that Google is well
positioned to capitalize on the mobile space with its search dominance. Currently,
advertisers can elect to place mobile search or content ads through AdWords.
Yahoo! Enters Carrier Partnerships
Similar to Google, Yahoo! is focused on increasing the distribution of its mobile
products. Yahoo! recently announced nine new partnerships with mobile operators
across Asia Pacific, as well as the availability of Yahoo! Go 2.0 in Chinese language
for Taiwan. These new partnerships bring the total distribution partnership count to
20, and include Rogers Communications, Telefonica, BPL Mobile, and 3 Group. We
believe that these agreements, in addition to the company’s leading email platform
and content portal, will firmly establish Yahoo! in the mobile market.
The Yahoo! Go 2.0 application allows consumers to personalize their mobile Internet
experience with content across the Internet and access to oneSearch. Users are
offered access to Yahoo! Go widgets, personal channels for email, local information,
satellite and hybrid maps, news sports, finance, entertainment, weather, Flickr,
search, and some GPS integration capabilities.
On the advertising front, Yahoo! offers mobile display advertising in 19 countries
with search marketing live in the U.S., the U.K., and Japan. Yahoo! is also the
exclusive advertising partner for Vodafone in the U.K. Publishers can use Yahoo!'s
Mobile Publisher Services to increase the discovery, distribution, and monetization
of their content on mobile phones and to access the Yahoo! Mobile Ad Network,
Mobile Content Engine, Mobile Media Directory, and Mobile Site Submit.
MSN Updates Its Mobile Portal and Acquires Ad Firm
Earlier this summer, Microsoft launched MSN Mobile, a redesigned portal providing
customers with access to email, news, sports, entertainment, local movie listings,
maps and directions, Windows Live Messenger, and Live Search. Like Yahoo!,
Microsoft is pursuing alliances with operators to integrate MSN Mobile on WAP
home pages.
Microsoft now has a firm footing in the mobile advertising world with its May
announcement of the acquisition of Screen Tonic, a Paris based company that
specializes in delivering location-based ads to mobile devices. ScreenTonic's
platform, called Stamp, enables delivery of text or banner links on portals, ads in
SMS (Short Message Service) messages and ads in mobile Web pages that vary
depending on where the reader is located.
84
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Mobile Payment Business Outlook
Mobile networks cover over 80% of the world’s population and over 2.7B people
have access to mobile phones. Meanwhile the global remittance market is expected
to grow at a 10.2% CAGR between 2000 and 2008 as the world’s population has
become more mobile. In this section we analyze the impact of the growth in the
global remittance market and mobile phone technology on the emerging payment
portals designed to take advantage of this growth.
• Global remittance is expected to grow 10.9% in 2008. According to Celent, the
global remittance market is expected to grow at a 10.2% CAGR between 2000
and 2008 as the global population becomes more mobile. Inexpensive methods
for P2P money transfers do not exist, except in the most developed remittance
corridors. Mobile money transfer solutions could provide an inexpensive solution
for the 200M people who are involved in the global remittance trade.
• Increased utilization of mobile phones and broadband mobile networks
provides opportunity for growth in mobile payments business. According to
the CDMA Association, there are over 402B 3G subscribers around the world
and according to JPMorgan’s estimates, global mobile phone penetration is
expected to reach 68% by 2010. With lower infrastructure costs, we expect
mobile Internet penetration growth to exceed land-based broadband penetration
growth during the next five years. We believe increased mobile broadband
penetration provides a robust platform for growth in both the mobile remittance
and m-commerce business.
• M-commerce is expected to grow as mobile Internet usage increases.
According to Jupiter Research, m-commerce was a $30B industry in 2006. While
most m-commerce money was spent on phone features, the amount of money
spent on physical purchases still remains relatively small. However, we expect
this number to grow as broadband Internet connectivity increases and the
difference between accessing the Internet from a mobile phone compared to a
broadband connected PC is minimized. While we expect POS transactions to
increase, we believe users will be slow to warm to NFC devices and bar-code
displays will be limited to ticket purchases (both transportation and
entertainment) and coupons.
• While a number of players are currently looking to enter the mobile
payment business, we expect only a few to survive. In the U.S., PayPal Mobile
and Textpayme both benefit from their relationships with the large online
retailers, eBay and Amazon, respectively. We believe smaller players who enter
the field will eventually need to team up with bigger operators, such as Obopay’s
relationship with Citibank, in order to compete against the likes of Western
Union, MasterCard, and major banks.
Background
Global Remittance Is a $311B Market
Celent estimates that over $311B in 2007 was transferred in the global remittance
market, and global remittance is expected to grow at a 10.2% CAGR between 2000
and 2008. The mobile global population and the desire to send money back to family
have led to the strong growth in remittance. The United Nation estimates that about
3% of the world's population, or roughly 175M people, is migrant, with the stock of
85
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
immigrants to high-income countries growing at 3% per annum between 1980 and
2000.
With about 31% of the population in developing countries under the age of 14, vs.
14% in developed countries, global migration is expected to remain robust. The
World Bank highlights two drivers behind the strong migration trends through 2025.
They include:
¾
The labor force in high-income countries is expected to decline. The
World Bank expects the labor force in high-income countries to peak
near 500M in 2010, then fall to 475M by 2025. This would lead to 100
workers supporting 111 dependents, compared to less than 100 today.
As a result, there could be greater demand for workers in the labor
force.
¾
Developing countries can supply the needed labor. With a large
population under the age of 14, and higher birth rates, the developing
world is expected to supply 1B workers by 2025, many of whom will
migrate to higher income countries to meet their labor demands.
These workers likely would continue to send money back to their country of origin.
According to the World Bank's base case scenario, new migrant workers could earn
as much as $481B more in real (after-tax) income in high-income countries than they
would have if they stayed in the developing countries. A large portion of this excess
wealth would likely find its way back to the migrant worker's country of origin
through remittance channels.
Figure 54: Global Remittance Receive Trends
$ in billions
400
350
300
250
200
150
159
167
183
2000
2001
2002
213
233
256
281
311
345
100
50
0
2003
2004
2005E
2006E
2007E
2008E
Source: Celent
Regulations and competition can
have a major impact on
remittance fees.
86
Inefficiencies and high costs still impact a large part of the remittance market
Despite the robustness of the global remittance market, the cost of remitting remains
high, except in the most developed and competitive markets. According to the World
Bank, the cost to transfer $200 (the average remittance size), excluding foreign
exchange fees, ranges as high as 17% between the United States and Columbia to as
little as 0.4% between the U.S. and the Philippines. Fees are often impacted by
regulation (see U.S. to Columbia example) and competition. We believe that there
are 4 main reasons for high remittance fees:
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
1.
Lack of competition
2.
Lack of innovation
3.
Burdensome regulatory and compliance requirements
4.
Low remittance volume in certain markets.
Table 51: Approximate Cost of Remitting $200
% of principal amount
Belgium to Nigeria*
Belgium to Senegal*
Hong Kong, China to the
Philippines
New Zealand to Tonga ($300)
Russia to Ukraine
South Africa to Mozambique
Saudi Arabia to Pakistan
United Arab Emirates to India
United Kingdom to India
United Kingdom to the
Philippines
United States to Columbia
United States to Mexico
United States to Philippines
Major MTOs
12.0
10.0
4.5
Banks
6.0
-
Other MTOs
9.8
6.4
-
Hawala
-
12.0
4.0
3.6
5.5
11.0
-
3.0
3.0
1.0
0.4
5.2
6.0
0.4-5.0
8.8
2.5
2.3
-
1-2
1-2
-
5.0
1.2-2.0
17.0
3.0
0.4-1.8
10.0
4.7
-
-
Source: World Bank
There are solutions to help drive down remittance costs
The low cost of remittance in the Philippines is the result of utilizing new
technologies and competitive pressures. Smart Communications, the largest mobile
phone provider in the Philippines, has set up an SMS-based text messaging service to
transfer money (see the SMS section below). Users can withdraw money using a
debit card (see Obopay below) or through a number of stores that Smart has formed
partnerships with, including McDonalds, gas stations and 7-11s. Smart has also
formed partnerships with a number of remittance companies. The simple SMS
technology helps keep costs down, and as a result, the Philippines have one of the
lowest international remittance costs (see Table 1 above).
Figure 55: Barriers to Entry Cited by Remittance Providers
% of responding firms
Accessing U.S. financial
Establishing commercial contacts
Technology
Acquiring know -how
Building customer trust
Getting licenses abroad
Funding w orking capital
Getting U.S. bond
Getting bank account
Building compliance sy stems
Creating agent netw ork
Getting U.S. Licenses
7
7
11
14
16
18.2
23
23
0
5
10
15
20
25
27
27
30
32
35
40
40
45
Source: World Bank
87
Imran Khan
(1-212) 622-6693
[email protected]
Increased competition and use
of new technologies can help
lower remittance costs.
North America Equity Research
02 January 2008
While there are a number of barriers to entry in the global remittance market, we
believe there is ample room for new entrants to come into the market and provide
lower cost solutions for most of the world's population. The growth of new money
transfer options, from PayPal in the US, to Smart Communications in the Philippines,
demonstrates that it is possible for new entrants to not only come into the market but
also to thrive and make a meaningful impact; although many smaller operations may
eventually be forced to team up with larger money transfer firms or banks.
Figure 56: Money Transfer Operating Margins
%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
31.0%
17.0%
19.3%
32.0%
15.7%
29.1%
18.7%
18.6%
10.9%
2004
Global Pay ments (Money Transfer)
2005
Money Gram (Global Fund Transfer)
2006
Western Union (C2C)
Source: Company reports.
We believe the growing mobile phone market provides a
platform to grow lower cost remittance solutions
The mobile market is a large and quickly growing industry with an estimated 2.7B
mobile subscribers worldwide growing at an estimated pace of 23% Y/Y. Given this
level of reach, we believe mobile solutions provide an attractive method to send
money around the world. We believe there are three key reasons that make the
mobile market a viable solution to lower remittance costs.
On a worldwide basis, 41% of
the population has mobile
subscriptions vs. 4% with
broadband subscriptions
88
1.
We estimate that 67% of Americans are mobile phone subscribers while
only 57% have broadband subscriptions.
2.
We believe that this disparity is even greater in developing countries. In
China, for example, our estimates indicate there are approximately 35
mobile subscribers per 100 persons but only 4 broadband subscribers per
100 people.
3.
On a worldwide basis, 41% of the population has mobile subscriptions vs.
4% with broadband subscriptions. JPMorgan's Wireless team expects
mobile penetration to reach 68% by 2010.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 52: Mobile and Broadband Penetration by Country
millions
Country
Population (M)
Broadband
Subs (M)
BB Subs per
100 Persons
Mobile Subs
(M)
Egypt
Morocco
South Africa
Africa
China
Hong Kong
India
Indonesia
Japan
Malaysia
Pakistan
Philippines
South Korea
Taiwan
Thailand
Vietnam
Asia Pacific
Austria
Belgium
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Italy
Netherlands
Norway
Poland
Portugal
Romania
Russia
Spain
Sweden
Switzerland
Turkey
Ukraine
United Kingdom
Europe
Iran
Israel
Middle East
Canada
Mexico
United States
North America
Australia
New Zealand
Oceania
Argentina
Brazil
Chile
Colombia
Peru
Venezuela
Latin America
71.4
30.7
47.6
914.3
1,323.7
7.1
1,119.7
225.5
128.2
25.8
157.0
84.5
48.0
22.8
64.8
85.3
3,693.0
8.2
10.4
10.2
5.4
5.3
60.7
82.7
11.1
10.1
58.1
16.3
4.6
38.5
10.5
21.6
142.5
43.4
9.1
7.3
74.2
46.0
59.8
813.1
69.1
6.4
190.0
32.4
108.3
299.7
439.0
20.4
4.0
33.2
39.1
188.9
16.5
46.3
28.4
27.2
461.8
0.1
0.3
0.2
2.9
47.0
1.5
2.0
0.5
24.2
0.7
0.1
0.1
12.8
4.4
0.3
0.3
99.6
1.5
2.0
1.0
1.6
1.3
11.1
12.4
0.3
0.8
8.0
4.7
1.1
2.0
1.4
0.4
2.1
5.9
2.1
2.0
2.1
0.1
11.6
72.4
NA
1.5
3.8
7.2
3.0
56.5
66.6
3.5
0.5
4.0
1.1
4.9
1.1
0.5
0.4
0.4
9.7
0.1
1.0
0.5
0.3
3.6
21.6
0.2
0.2
19.0
2.7
0.1
0.2
26.1
19.2
0.5
0.4
2.7
17.8
19.5
9.4
29.1
25.0
17.7
15.1
2.8
7.9
13.8
28.5
24.7
5.3
12.8
1.8
1.5
14.6
22.7
25.9
3.0
0.2
19.1
9.0
NA
23.5
2.0
21.5
2.7
18.8
15.2
17.3
11.7
11.8
2.7
2.6
6.8
1.1
1.5
1.6
2.6
13.6
16.0
39.7
193.8
461.1
9.4
166.1
63.8
101.7
19.5
34.5
42.9
40.2
23.2
40.8
15.5
1,073.3
9.3
9.7
12.1
5.8
5.7
51.7
84.3
11.1
10.0
71.5
15.8
5.0
36.7
12.2
17.4
150.0
46.2
9.6
7.4
52.7
49.1
69.7
797.6
13.7
8.4
63.6
17.0
57.0
201.7
275.7
19.8
3.5
24.1
31.5
99.9
12.5
29.8
8.5
18.8
282.3
Mobile Subs
per 100
Persons
19.1
52.1
83.3
21.2
34.8
131.5
14.8
28.3
79.3
75.5
22.0
50.8
83.8
102.0
63.0
18.2
29.1
112.8
92.6
119.0
107.3
107.8
85.1
101.9
99.6
99.0
123.1
97.2
108.6
95.5
116.0
80.5
105.2
106.4
105.9
102.1
71.0
106.7
116.4
98.1
19.4
122.7
33.5
52.5
52.6
67.3
62.8
97.0
87.6
72.6
80.5
52.9
75.6
64.3
30.0
69.0
61.1
World Wide
6,544.4
259.1
3.9
2,710.4
41.4
Source: CIA Government Stats (http://www.cia.gov/cia/publications/factbook/index.html), International Telecommunications Union
(http://www.itu.int/ITU-D/ict/statistics), JPMorgan estimates.
89
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Developing payment processing solutions geared around mobile devices would
greatly improve the reach of current remittance options, in our view. With the
growing prevalence of mobile devices, someone in Ghana may some day be able to
transfer money to someone in Northern Alaska without needing to visit a bank or
Western Union. As the example of the Philippines demonstrates, this may even be at
a lower cost than the options that are currently available.
Increased Mobile Internet Penetration Gives Users the
Freedom to Access and Send Information from Almost
Anywhere
According to the FCC,
individuals in the U.S. with highspeed mobile access increased
to 2.4M in Dec. 2006, from 2,574
in June 2005.
U.S. mobile Internet usage has been slow to take off; the number of users with
Internet capable phones and high-speed mobile data connections has remained small.
However, that is changing as more users buy data-enabled phones, such as the
iPhone, and access high-speed mobile data networks such as Sprint’s EVDO network
and AT&T’s HSDPA network. According the Pew Internet & American Life Project
report on mobile usage, only 14% of mobile subscribers use their phones to access
the Internet, but 16% stated that they would like to have mobile Internet access.
Despite a low penetration, mobile broadband access (defined as speeds of 200kps or
more in at least one direction) continues to grow, increasing from 2,574 individual
users in June 2005 to 2.4M individual users (21.9M if business devices are included)
in Dec. 2006, according to the FCC. We expect mobile broadband growth to remain
robust and to play a key role in the adaptation of m-commerce and mobile payment
solutions.
Figure 57: U.S. Mobile Device Usage
%
Trade instant messages
Perform Internet searches
Send/receiv e email
Access the Internet
Play games
Take still pictures
Send/receiv e tex t messages
0%
10%
20%
Currently use
30%
40%
50%
60%
Would like to hav e
Source: Pew Internet & American Life Project
Mobile Users Are Adopting SMS as a Primary Way to
Communicate
In the U.S., 65% of 18-29 year
olds use text messaging.
90
While mobile Internet growth has been slow, text messaging, or SMS, use has
thrived, unencumbered by slow connections or text-heavy displays. According to the
Pew Internet & American Life Project, over 35% of all cell phone users use textbased messaging, while 65% of those 18-29 use text messaging. SMS growth in the
US has been robust during the past 2 years, growing 300%, according to the CTIA.
SMS usage outside the US has also been strong, with 41% of Europeans using text
messaging services. SMS, which doesn’t require the latest mobile technology or
high-priced cell phones, provides a low-cost method to grow the mobile remittance
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
market in developing countries and to attract the greatest user base in more
developed markets like the U.S. and Europe.
Figure 58: US SMS Usage by Age Group
%
65%
70%
60%
50%
40%
37%
35%
30%
13%
20%
8%
10%
0%
Total
18-29
30-49
50-64
65+
Source: Pew Internet & American Life Project
Figure 59: June Monthly SMS Usage in the US and UK
Billions of SMS Messages
35.0
30.0
25.0
20.0
15.0
10.0
5.0
-
28.8
12.5
7.2
2005
4.4
3.4
2.6
2006
US
2007
UK
Source: CTIA, Test.it, JPMorgan Estimates
We Expect Mobile Commerce to be a Catalyst for Growth in
Mobile Payment Platforms
According to Jupiter Research, mobile commerce was a $30B market in 2006. Most
m-commerce has been, and continues to be, limited to the purchase of customizable
ringers, downloadable games and screensavers, all features that are used on the
phone. The use of a mobile phone to purchase physical merchandise has remained
small. However, we expect m-commerce transactions to grow as more mobile users
gain access broadband mobile networks and phones with improved display and
Internet features. Jupiter Research expects m-commerce to reach $63B by 2010. As
growth an e-commerce helped online payment providers, such as PayPal, grow its
transaction volume, we expect strong growth in m-commerce to help grow mobile
payment transaction volume and create an incentive for companies looking to enter
the space.
91
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 60: PayPal Transaction Volume Growth and eCommerce Penetration 2000-2007E
$ in millions
500,000
12.0%
400,000
10.0%
8.0%
300,000
6.0%
200,000
4.0%
100,000
2.0%
-
0.0%
2000
2001
eCommerce Sales
2002
2003
2004
Pay Pal TPV
2005
2006
2007E
TPV as % eCommerce
Source: US Department of Commerce, JPMorgan estimates, Company data.
We expect point of sale transactions to have a limited impact on mobile
commerce growth
Companies such as Nokia and Samsung have looked at adding microchips to cell
phones to drive mobile commerce growth at the retail store level. Using a chip
embedded in their cell phone, a user can scan their phone near a reader and pay for
merchandise at the store (point of sale) using funds from their credit card, bank
account or other account, possibly set up through the cell phone provider.
While companies focus on near field communication solution (NFC) to drive point of
sale (POS) transactions, the marketplace for NFC solutions and the new technologies
being tested are beyond the scope of this report. However, we are skeptical of the
long-term viability of NFC solutions principally for four reasons –
1.
We believe most people are fairly happy with their current POS solutions –
NFC using credit cards, regular credit and debit cards and cash, and have
little incentive to try something new.
2.
Security is an issue for many users who are concerned about not only extra
phone charges when they lose their phone, but also someone purchasing
items with it. Also, many people are concerned about accidental charges,
since their phone only needs to pass in the vicinity of a reader.
3.
Having a chip embedded in the cell phone limits a customer’s choices and
the ability to change phones, mobile providers or credit card companies
easily.
4.
Transactions can require the cooperation of as many as seven separate
parties: (1) consumer, (2) merchant, (3) the consumer's bank, (4) the
merchant's bank, (5) the payment network, (6) mobile operator, and (7)
merchant processor. All of these parties create additional transaction costs
and make implementation more difficult.
Bar codes are another payment option for POS transactions. Under this method, a
mobile user purchases an item online, usually a ticket, and then receives a bar code
verifying that the payment was made. When the user goes to use the ticket, or pick up
the merchandise, the bar code on the phone is scanned. Mobilrelay (mbo.com) is one
92
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
company that sells movie tickets online and sends users a bar code to confirm their
purchase. In Belgian, users who purchase tickets for the De Lijn train line between
Antwerp and Ghent can use SMS to receive rail tickets. Bar codes and SMS payment
confirmations are essentially a replacement for the printed ticket. As a result, we
expect usage will be primarily limited to entertainment and travel ticket purchases.
Current Mobile Payment Systems
SMS-Based Solutions
With the popularity of SMS services on mobile networks, and helped by the fact that
SMS-based services can operate independently of the users mobile service provider,
SMS-based solutions are the most common option for mobile P2P money transfers.
A typical P2P money transfer takes place in the following steps:
1.
Send a text message to the Payment provider's number. Include the amount
and phone number or email address (some providers, such as PayPal, allow
transfers to PayPal members using an email address).
2.
Since the transaction occurs over an unsecured SMS channel, the payment
processor will typically send a text message or make a phone call to confirm
the payment.
3.
Once the payment is confirmed, the recipient receives a text or email
notifying them that they have funds available in their account. If the
recipient is not a current user of the payment service, they are invited to
join, and typically cannot access their funds until they do so. Money that is
not claimed is usually returned to the sender after a set period of time.
Users of SMS-based solutions can often use SMS messaging for other accountmanagement services. Some common features include:
1.
The ability to check your balance by sending a predetermined text message
(ex. bal) to the service provider’s number.
2.
The ability to request money from other users. This can be done by sending
a text message to the provider’s number with the user’s information and the
amount requested. Funds are not deposited until the transfer is confirmed by
the user sending the money.
3.
Users can also text to buy items using SMS payment solutions.
Adding and withdrawing money is usually done online, through a web-based
interface, or sometimes through the use of a specially branded credit/debit card.
Web Interface and Software-Based Solutions
Slow speeds and difficult to read text displays have kept many away from web
interface solutions. However, as newer mobile broadband technologies (3G, etc) and
better graphical interfaces (i.e. Apple iPhone) are rolled out, we expect cell phone
Internet usage to grow. Web-based interface has the benefit of operability on most
service provider networks (at least those that offer advanced Internet capabilities)
and eliminates the need to download software on the user’s phone. It also creates a
more secure transmission environment; the sender usually must log in with a user
93
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
name and password prior to sending money, and can enter a PIN number through the
web interface, eliminating the need to receive a callback and/or text message
verifying the sender’s information.
Figure 61: How KushCash Works
Source: www.kushcash.com
Software-based applications, offered by firms such as KushCash and retail banks
(such as Bank of America, Citibank and Wachovia), offer another secure solution.
The drawback to using software-based applications is that their usage is limited to
certain carrier networks, which often depend more on relationships than the size of
the network, and model of cell phones, although this limitation also exists for both
SMS-based and web-based services. The advantage of software solutions is usually a
more secure environment, as transfer requests are encrypted, and increased
functionality over SMS-based solutions.
Conclusions
Global migration has created a large market opportunity in remittance
The increase in global migration has created a global remittance market that is
expected to reach $345B by 2008, according to Celent. According to the World Bank
remittance options for many people still remain high, with some people paying fees
of 10% or more, before foreign currency exchange costs. We believe there is room
for new competitors, other than the existing money transfer companies, to provide
lower cost solutions, such as Smart Communications does in the Philippines.
The growth in mobile penetration creates an attractive vehicle to transfer funds.
With over 68% of the world expected to have a mobile phone by 2010, we believe
that mobile technology offers a viable and low-cost solution in the global remittance
market. The attractiveness of this market has not been lost on the big players in the
space as Western Union and MasterCard have teamed up with the GSM Association
and Citibank has teamed with Obopay to offer mobile money transfer solutions.
94
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
M-commerce is still in its early stages but should grow with high-speed
connections
We believe that m-commerce is still in its early stages, as users mostly limit their
purchases to cell phone features, such as ring tones, games and screensavers. We
expect this to change as more mobile users gain access to high-speed mobile
connections on 3G and later mobile devices and viewing screens continue to
improve, as on Apple's iPhone.
POS m-commerce solutions are not expected to take off
We believe that mobile phone subscribers will be slow to adopt near field
communication solutions (NFC) as they already have a number of viable payment
options. Since a significant amount of capital needs to be spent developing an NFC
infrastructure, including readers, we believe usage will be limited to wealthier
countries and usage will be more prominent among those who do not have other
viable payment alternatives, such as teenagers. We expect bar code POS solutions to
be an attractive alternative to paper ticket sales, for entertainment events and travel,
however, usage should be limited to more developed markets.
SMS and web-based solutions are expected to remain the main portals for
mobile money transfers
We expect SMS and web-based solutions to be the most successful mobile payment
solutions. SMS service is widely available and used by a large portion of young
mobile subscribers. The service does not require advanced broadband technology or
expensive hardware and is relatively inexpensive to implement, which should help
drive its usage. However, security is a concern, as most SMS messages are
unencrypted, and a user most give a PIN number or password in response to a text
message or voice call. Web-based solutions offer a more secure alternative for those
with a broadband mobile Internet connection and Internet-capable phone.
Current Providers
KushCash
KushCash is a software-based money transfer solution based in Southern California.
Its user base is currently small and the company is focused on growing in its core
California market. The application is available on select phones that operate on the
Boost, Cingular and Sprint networks and through a web-based interface. A user can
access its KushCash account through 1) the mobile application or 2) an Internet or
mobile Internet browser. In addition users can send, receive and borrow money from
KushCash members using the KushCash application.
Table 53: KushCash
Fees to:
Open an Account
Add Money
Send Money
Withdraw to Bank
Receive Money
FREE
2.80% + $0.30
FREE
0.5
0.5
How it works
Install KushCash directly to your supported phone.
1. Register an account online.
2. Follow the download instructions.
3. Instantly install KushCash.
Source: www.kushcash.com.
95
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Obopay
Obopay was launched in 2005 and some of its investors include ONSET Ventures,
Qualcomm, Redpoint Ventures and Richmond Management. The service operates on
any SMS or web-enabled phone device. Obopay works primarily as a P2P service,
however, it was teamed up with Verizon to offer the Verizon Get It Now Catalog,
that allows the purchase of digital downloads and physical goods. Users can use
credit cards, bank accounts and even an Obopay-branded ATM card to deposit and
withdraw funds. Obopay founded BillMonk, which allows users to lend and borrow
money from friends and to keep track of and settle expenses. BillMonk users can use
Obopay to settle and collect their debts. Other Obopay partners include Citibank and
AIM, which offers an Obopay plug-in.
Table 54: Obopay
Fees to:
Sign up for Obopay
Receive money
Receive money as a merchant (get paid)
Withdraw money to your bank account
Send money (or accept a request for money)
Add money from your credit or debit card (standard)
Add money from your bank account (economy)
FEE
Free
Free
Free
Free
$0.10
1.50%
Fee is
waived
Mobile Operators
Verizon Wireless'
HELIO
Cellular South
Merchants
RIPmobile
Online Partners
AIM
Source: www.obopay.com.
PayPal Mobile
PayPal Mobile is the mobile version of PayPal’s payment processing platform. The
platform can work either via SMS, with users receiving a callback or text message to
verify their PIN, or through a web based interface. There are no extra fees for
sending money via PayPal Mobile as opposed to using the regular PayPal service. In
order to purchase items on eBay, users must first download an application to their
cell phone. Users can also buy merchandise from other vendors on web-enabled
phones or by sending a text message to a number on a Text to Buy ad. Users can
even use SMS messaging to change currencies.
96
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 55: PayPal Mobile
Fees to
Open an Account
Send Money
Withdraw Funds
Add Funds
Receive payments funded by PayPal Balance,
PayPal Instant Transfer or PayPal eCheck
Receive payments funded by Credit Card, Debit
Card or Buyer Credit
Multiple Currency Transactions
Personal Account
Free
Free
Free for banks in the U.S.
Fees for other banks
Free
Free
4.9% + $0.30 (in U.S.)**
Additional fees for cross
border payments
Exchange rate includes a
2.5% fee**
Additional fees for cross
border payments
Premier/Business Account
Free
Free
Free for banks in the U.S.
Fees for other banks
Free
1.9-%-2.9% + 0.30 USD (in
U.S.)
1.9-%-2.9% + 0.30 USD (in
U.S.)
Additional fees for cross border
payments
Exchange rate includes a 2.5%
fee
Additional fees for cross border
payments
Supported Carriers
Alltel
AT&T
Cincinnati Bell
Midwest Wireless
Sprint
T-Mobile
T-Mobile (prepaid)
Verizon
Virgin Mobile
Source: www.paypal.com/mobile.
Note: Personal accounts may not receive payments funded by credit card, debit card or buyer credit for sales on eBay. Users who
would like to receive these payments must upgrade to a premier or business account.
Textpayme
Textpayme is an SMS-based money transfer solution that recently moved out of its
beta testing phase and is linked to Amazon's Payment Services. In order to create a
Textpayme account, users must first create, or already have, an Amazon account. In
addition to being able to transfer money, users can also use Textpayme to purchase
items on Amazon.com. In order to encourage users to try its service, the company is
currently offering $5 to new members and since it is SMS-based, the service is
accessible to subscribers on any mobile network that offers text messaging. Fees are
only charged when money is added via credit card. Bank deposits and withdrawals
are free, and users can choose to receive their money in the form of Amazon gift
certificates.
97
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 56: Textpayme
Fees to:
Signup for a TextPayMe Account
Send Money
Receive Money
Deposit Funds through Bank Account
Withdraw Funds to Bank Account
Auto Debit from Credit Card
Supported Carriers
AT&T
Alltel
Boost
Midwest Wireless
Nextel Communications
Sprint PCS
T-Mobile
Verizon Wireless
Source: www.Textpayme.com.
98
Free
Free
Free
Free
Free
Free for first $200 ($0.15 + 1.35% after)
China Sector Outlook
North America Equity Research
02 January 2008
Strong Internet User Growth Continues
China’s Internet users continue to swell, and have crossed 162 million as of Jun-07,
compared to 137 million as of Dec-06 and 123 million as of Jun-06 (or up ~32%
Y/Y), as per CNNIC (China Internet Network Information Center). This makes
China’s Internet population second only to the US (~212M). However, China’s
population penetration is still only 12%, versus 65%+ in more developed Internet
markets like Japan, Korea and the US. We expect the Internet population in China to
continue to grow robustly and reach ~239 million by 2010 (‘06-‘10E CAGR of
15%).
Figure 62: China Internet Users and Penetration Forecast
250
200
162
150
100
50
23 27
34
46
59
68
80
87 94
103
111
123
175
189
200
212
221
230 239
20%
18%
16%
14%
137
12%
10%
8%
6%
4%
2%
0%
Number of China Internet Users (Left, millions)
Dec-10E
Jun-10E
Dec-09E
Jun-09E
Dec-08E
Jun-08E
Jun-07
Dec-07E
Dec-06
Jun-06
Dec-05
Jun-05
Jun-04
Dec-04
Dec-03
Jun-03
Dec-02
Jun-02
Dec-01
Jun-01
0
Dec-00
Imran Khan
(1-212) 622-6693
[email protected]
Penetration Rate as % of Total Population (Right)
Source: CNNIC, JPMorgan estimates.
Besides the typical benefits of Internet access (information, communication, etc.), we
believe a few China-specific reasons still continue to drive Internet usage: 1)
relatively low-cost entertainment source (Internet cafe access fee of ~US$0.30 per
hour to enjoy online games, online music, movie downloads), 2) community tools for
the large floating population in China (eg. workers moving from rural to urban
areas), 3) alternative news source (due to few media with nationwide coverage).
Table 57: Common Applications of Internet in China
% of Users
Information
News
Search engine
Communication
IM
E-mail
Entertainment
Online music
Online video
Internet games
77.3%
74.8%
69.8%
55.4%
% of Users
Life Assistance
Look for jobs
Online education
Online shopping
Online banking
Stock
15.2%
24.0%
25.5%
20.9%
14.1%
68.5%
61.1%
47.0%
Source: CNNIC Survey (Jun-07).
101
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 63: Broadband Internet Users in China
Figure 64: Broadband Internet Users as % of Total Internet Users
140
122
120
43
7
2
10
46%
50%
53
20%
10%
0
Dec- Jun-
02
4%
11%
02
03
Dec- Jun03
Dec- Jun- Dec- Jun- Dec- Jun-
04
04
05
05
06
06
14%
Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun-
07
02
02
Broadband Internet Users (millions)
40.0%
03
04
04
05
05
06
06
Figure 66: Main Locations of Internet Access in China
80%
34%
74%
70%
60%
30.0%
19%
18%
03
Broadband users as % of total Internet users
Figure 65: China Internet Users by Age Group
50%
10%
10.0%
8%
37%
40%
30%
7%
3%
1%
20%
10%
0%
0.0%
102
63%
0%
Jun-
20.0%
58%
22%
30%
17
51%
66%
36%
40%
31
40
20
60%
64
60
75%
70%
77
80
90%
80%
91
100
100%
Under
18 -
25 -
31 -
36 -
41 -
51 -
Abov e
18
24
30
35
40
50
60
60
31%
12%
Home
Internet Café
Workplace
School
07
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Online Advertising
Remain positive on the secular high growth online
advertising sector
Online advertising (display and search advertising) in China continued to see strong
growth in 2007, with ~50% YoY growth, as per our estimates. Online advertising
thus accounted for ~6.7% of the total advertising market in China in 2007 (as per our
estimates), up from ~5.2% in 2006.
We remain positive on the online advertising sector in China and forecast 50%
growth in 2008. We expect the 2008 Beijing Olympics to act as a significant growth
driver in the near to medium term, as advertisers try to take advantage of this key
event (a source of great national pride) to build and strengthen their brand awareness
among consumers.
Table 58: China Online Advertising Forecast
Branded Advertising Market (US$M)
Email Advertising Market (US$M)
PPC Search Market (US$M)
Fixed Price Ranking (US$M)
Total Online Ad Market (US$M)
Growth (%)
China overall ad market (US$M)
Online as % of total China ad market
2004
205
8
37
37
287
97%
8,449
3.4%
2005
287
11
67
42
407
42%
10,184
4.0%
2006
425
14
140
48
626
54%
12,051
5.2%
2007E
586
16
309
50
961
53%
14,236
6.7%
2008E
809
17
562
53
1,441
50%
17,479
8.2%
2009E
970
19
911
55
1,956
36%
19,588
10.0%
2010E
1,213
21
1,384
58
2,677
37%
22,918
11.7%
2011E
1,431
23
2,046
61
3,561
33%
26,356
13.5%
2012E
1,689
25
2,748
64
4,527
27%
30,309
14.9%
2013E
1,993
28
3,507
68
5,596
24%
34,855
16.1%
2014E
2,352
31
4,310
71
6,764
21%
40,084
16.9%
2015E
2,775
34
5,196
75
8,080
19%
46,096
17.5%
Source: CNNIC, JPMorgan estimates.
The key drivers for the continued momentum in online advertising remain: (1) strong
economic growth across sectors, (2) continued increase in disposable income and
consumer spending, (3) competitive business environment and increasing brand
investments across sectors and (4) secular growth in advertising dollars moving
online (from more traditional media, as users spend more time online).
Figure 67: Nominal GDP Growth in China
Figure 68: Ad Spending as % of GDP
Units: RMB Bn (Y-axis)
25,000
1992-2006 CAGR of 16%
20,000
0.4%
15,000
0.3%
10,000
0.2%
5,000
0.1%
0
0.47%
0.5%
0.34%
0.25%
0.38%
0.45% 0.46%
0.39%
0.27%
0.0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: CEIC/SAIC.
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: CEIC/SAIC.
103
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 69: Growth in Urban Disposal Income per Capita
Figure 70: Growth in Retail Sales of Consumer Goods
Units: RMB
Units: RMB Bn
1992-2006 CAGR of 13%
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: CEIC.
Figure 72: China Online Ad Market as % of Total Ad Market
Average Access Time Per Week (Left, hours)
15.9
13.0
8.7
8.5
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: CEIC.
Figure 71: Average Weekly Online Time
20
18
16
14
12
10
8
6
4
2
0
1992-2006 CAGR of 15%
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
8.3
13.4
12.3
13.2
16.5
16.9
18.6
14.0
9.8
4,000
13.5%
3,500
Average Access Time Per Week (Left, hours)
Source: CNNIC.
10%
6.7%
2,000
Jun-01 Dec- Jun-02 Dec- Jun-03 Dec- Jun-04 Dec- Jun-05 Dec- Jun-06 Dec- Jun-07
01
02
03
04
05
06
8%
5.2%
3.4%
6%
4.0%
1,000
4%
500
2%
0%
2004
2005
2006
2007E
2008E
2009E
Online ad market size (US$m,left)
As % of total ad market (% , Right)
Source: JPMorgan estimates.
104
12%
10.0%
8.2%
2,500
1,500
14%
11.7%
3,000
16%
2010E
2011E
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Branded Advertising Segment
Branded advertising strength should continue; Olympics
should give a boost in 2008
The branded advertising segment grew ~38% in 2007 to reach US$586 million, as
per our estimates. In terms of the advertiser sectors, automobiles, real estate and IT
remained the largest, (together accounting for 40%-50% of branded ad spend on top
portals), while financial services, FMCG and online games were among the fastest
growing (with 100%+ YoY growth in branded ad spend on top portals).
For 2008, we forecast the branded advertising segment to witness ~38% YoY growth
to reach US$809 million, with the Olympics being a key driver for the segment. We
expect listed portals such as Sina, Sohu, Tencent and NetEase to remain the market
leaders and be the key beneficiaries of the segment growth due to their strong brand
names, superior content offering and proven execution ability.
Figure 73: China Branded Advertising Forecast
1,600 72%
1,200
40%
800
400
205
287
2004
2005
38%
425
1,431
1,213
48%
20%
586
60%
970
38%
809
75%
45%
25%
18%
30%
15%
0
0%
2006
2007E
Branded Advertising Market (US$M,left)
2008E
2009E
2010E
2011E
YoY growth (% , Right)
Source: JPMorgan estimates.
Internet users’ online time continuing its up-trend
The duration of time spent online by users continues to increase in China. The
average weekly online time has increased to 18.6 hours for Chinese Internet users as
of June 2007 (as per CNNIC survey), up from 16.9 hours as of December 2006; the
average weekly online time has thus more than doubled over the last 5 years in China
(from 8.3 hours in June 2002). The factors that have contributed to the up-trend
include: (a) major portals have been increasing their content investments over the
past few years to make more information and differentiated content (such as the
NBA, European soccer leagues, Asian Games, Olympics lead-up, etc.) available to
users, and (b) the Internet is viewed in China as an alternative information source
that is more friendly and entertaining to use (as most traditional media remains
tightly controlled by the government).
105
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 74: Internet User Online Time Trend
20
13.0
14
12
8.7
8.5
13.4
12.3
13.2
16.9
16.5
15.9
16
10
18.6
Average Access Time Per Week (Left, hours)
18
14.0
9.8
8.3
8
6
4
2
0
Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07
Av erage Access Time Per Week (Left, hours)
Source: CNNIC.
Olympics should be a key driver in 2008
The 2008 Beijing Olympics should be a key driver for the overall advertising
industry in China, as well as for the online advertising sector. As a historical event
for China, and a matter of great national pride, advertisers will try to take advantage
of the Olympics to build and strengthen their brand awareness among consumers.
In terms of impact on leading players, we forecast both Sina and Sohu to experience
nearly 50% YoY growth in their branded advertising segments in 2008, up from
~40% YoY growth in 2007.
Figure 75: Sina Branded Ad Revenue Growth
350
300
250
200
150
100
50
0
Figure 76: Sohu Branded Ad Revenue Growth
49.9%
41.3%
120
40.4%
310
253
60.0%
50.0%
40.0%
169
22.9%
30.0%
20.0%
10.0%
0.0%
2006
2007E
2008E
Sina Branded Ad Rev enue (US$M, left)
Source: Company, JPMorgan estimates.
2009E
YoY grth (%, right)
200
150
100
188
48.4%
35.1%
79
40.0%
164
60.0%
50.0%
40.0%
111
30.0%
14.7%
50
20.0%
10.0%
0.0%
0
2006
2007E
2008E
Sohu Branded Ad Rev enue (US$M, left)
2009E
YoY grth (%, right)
Source: Company, JPMorgan estimates.
Sohu, being the official Beijing Olympics Internet content sponsor, has already
begun to see some benefits of ad spending by Olympics partners and sponsors Olympics sponsors as a group increased ad spending on Sohu by 60% YoY in 3Q07
and by 80% YoY in 2Q07 (These sponsors/partners include Coca Cola, Lenovo,
Adidas, Yili, Bank of China, Volkswagen, et al). Sohu believes that the larger
Olympics ad spending is yet to come, and the spending is likely to be in three phases:
106
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
(1) 4Q07 until early May: Advertisers likely will still be relatively slow in Olympicsrelated spending.
(2) From May until early August: The Olympics torch relay will begin in May, and
advertisers likely will increase their ad spending.
(3) During the month of August: The largest ad spending likely will take place
during the actual Olympics event.
Growth after the Olympics
We expect online ad spending to continue to grow after 2008, on the back of: (1)
strong domestic consumer growth and high industry competition should continue
even after Olympics, (2) while a portion of Olympics-related ad spend may come
from international companies targeting international visitors (buying ads in China
during Olympics to show their presence there) and will not come back postOlympics, we believe these international companies likely weill not use Chinese
Internet portals to advertise in the first place, (3) accelerated Internet usage likely in
China after Olympics – as Olympics are held during daytime, office workers likely
turn to Internet for updates, (4) various industries, such as FMCG, will likely
increase their percentage of online spending after the Olympics - as they are likely to
see good ROI during Olympics advertising, and (5) the 2010 World Expo in
Shanghai is another highly anticipated international event, and would provide
advertisers another opportunity to associate their products / brands with a highprofile international event that demonstrates the success of China.
Regulatory risk remains lower than other online sectors
We believe the regulatory risk remains lower for the portal online ad business,
compared to other segments in China, such as WVAS, online music or online games.
Online advertising is the most established online business in China (since the late
90s), and regulations and boundaries are well-understood by industry players. We
believe the leading portals have strict internal compliance departments and
automated content scans to ensure content is in compliance with government
standards. While Web 2.0 content such as music, video, and blogs has come to the
government’s attention, we believe if there is further regulatory tightening for Web
2.0 content, leading portals should be less impacted than pure Web 2.0 companies.
Leading portals are the most trusted by the government among Internet companies
and have the best compliance procedures; further, the financial impact would be less
significant because only a small portion of their revenues is likely to be from Web
2.0 content.
107
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Online Search
Online search advertising still in early high-growth stage
The online search segment in China was up ~120% YoY in 2007 to reach US$309
million, as per our estimates. We believe online search advertising is still in an early
high-growth stage in China, and forecast search revenues to experience 56% CAGR
over ‘07-'11, driven by: (1) rising Internet penetration in China, (2) significant
growth in websites and pages, (3) higher search usage (due to greater mass of web
content), and (4) large number of SMEs (with small ad budgets) turning to search
advertising (due to higher ROI).
For 2008, we expect the search advertising segment in China to witness ~82% YoY
growth to reach US$562 million. We expect Baidu to remain the dominant player in
China in the near to medium term and be the key beneficiary of the industry growth.
(Baidu’s market share is around 65%-70%, with nearest rivals Google and Yahoo!
together having around 25%-30% market share).
Table 59: China Paid Search Forecast
Avg Internet users (millions)
Number of search (billions)
Coverage
Click through rate
Price per click (RMB)
Market size (US$M)
YoY Growth (%)
2004
94
51
12%
20%
0.25
37
83%
2005
111
67
14%
21%
0.29
67
82%
2006
130
86
17%
22%
0.34
140
109%
2007E
168
119
21%
24%
0.40
309
120%
2008E
195
145
25%
26%
0.47
562
82%
2009E
217
169
29%
27%
0.55
911
62%
2010E
234
190
33%
28%
0.62
1,384
52%
Source: CNNIC, JPMorgan estimates. Note: Excluding distributor discount.
Search market outlook: Usage
As Internet users become more experienced, they look for information on the Internet
beyond the major portals. Entertainment-related content, such as pictures and music,
have always been popular in China. Going forward, we believe the nonentertainment-related searches, such as eCommerce, e-Government will continue to
gain popularity.
Table 60: Entertainment
comparison
Entertainment
option
Webcafes with
online games
Movie
Big Mac meal
Karaoke
Beijing subway
fee (one way)
Fee
Rmb2-4 per hour
Rmb30 - 60
Rmb20
Starting Rmb30
per hour
Rmb2-5
Source: JPMorgan estimates.
108
Growing usage in China
Latest statistics from CNNIC show that the number of users in China has reached
162 million (Jun-07). We expect usage to continue to grow driven by such factors as:
• Entertainment tool. Digital entertainment (MP3, movies, etc.), can be
downloaded from the web virtually free of cost or at a very low cost. Online
games—LAN-based, MMORPG, or casual board and chess games—are also
low-cost alternatives to offline entertainment. Internet is a low cost form of
entertainment—Internet café access is about Rmb2-4 / hr vs. Rmb40 for a movie.
• Communication tool. Migrant workers (~10% of total population, or 140M
people in China are floating population) as well as relocated white-collar workers
visit Internet cafés after work to use instant messenger and email, or to play
games or watch movies. Despite the government constantly monitoring these
services, blogs and bulletin board services have also increased in popularity in
China (as channels to express personal views and communicate with others).
2011E
253
214
38%
28%
0.69
2,046
48%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
• Information source. Most traditional media is still tightly controlled by the
government. Internet offers an alternative information source that is more
friendly and entertaining to use. Major portals have also been increasing their
content over the past few years to make more information available to users.
Other government initiatives, such as electronic tax filing, customer clearing, and
government agency websites, also help in improving Internet usage.
Surge in websites and webpages in China
China is no exception to the information boom. As of December 2006, there were
around 4.4 billion webpages, up from 650 million in December 2004 (CNNIC,
excludes 217 million overlapped pages). The number of websites (located in China)
is also rapidly growing. According to CNNIC, the number reached 1.3 million by
July 2007, up from 669k by end-2004. Despite the recent stricter registration
requirements, we believe the government strongly supports healthy websites. The
amount of information per page (in terms of number of bytes) is also on the rise.
Figure 77: Number of websites in China
Figure 78: Number of webpages in China
Number of w ebsites in China
Webpages (millions)
5,000
1,400,000
CAGR (02-06): 26%
1,200,000
4,000
1,000,000
CAGR (02-06): 131%
3,000
800,000
600,000
2,000
400,000
1,000
200,000
-
Source: CNNIC.
Jun-07
Dec-06
Jun-06
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Jun-02
Dec-02
Dec-01
0
2002
2003
2004
2005
2006
Source: CNNIC.
Note: Includes static and dynamic pages, excludes overlapped pages.
Users turning to searches in China
With information on the Internet ever expanding, it is natural that users turn to search
engines to get organized information on the Internet. As a result, the number of
searches in China is expected to increase by more than 4-fold from 2003 to 2008.
According to the 2006 CNNIC report, more than 80% of Internet users perform a
search every time they get on line.
109
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 79: Number of searches per day in China
400
Figure 80: Number of searches per user daily
357
350
295
300
2.5
2.0
236
250
1.5
177
200
150
96
136
1.5
1.7
1.9
2.0
1.0
0.5
100
50
1.3
1.8
0.5
24
0
0.0
2002
2003
2004
2005
2006 2007E 2008E
Number of search per day (million, Left)
Source: I Research, JPMorgan estimates.
Note: Includes traffic form toolbar and address bar.
2002
2003
2004 2005E 2006E 2007E 2008E
Search per Internet user per day (Left)
Source: I Research, JPMorgan estimates.
Note: Includes traffic form toolbar and address bar.
Search market outlook: Advertisers’ readiness
Online advertising accounts for only ~7% of the total ad spending in China in 2007.
The search revenue is even smaller, at approximately 37% of the online ad market.
As in the US, we believe the paid search ad is particularly well-suited for small and
medium enterprises (SME) in generating sales leads. Yet, as with the low Internet
adoption rate in China, paid search is still a new advertising concept for these
advertisers. Continuous education/marketing are required to drive market growth.
Large available SME market for search advertising but low Internet usage
According to the National Development and Reform Commission, Department of
Small and Medium-Sized Enterprises figures, as of end 2005, there were 43 million
SMEs in China. These SMEs are mainly 39 million individual businesses (these are
small businesses registered with some government departments). Statistics from
SAIC (State Administration for Industry & Commerce) suggest that the number of
SMEs in China is roughly 24 million. Despite the discrepancies, we believe the
overall number of SMEs is large.
According to SAIC, as of end of 2005, there were 4.3 million larger-size SMEs (that
are registered directly with SAIC). The total number of websites in China is 843,000
(as of December 2006). We estimate 60% of the websites are corporate (excluding
personal sites, bulletin boards, and inactive sites). Therefore, the number of corporate
websites in China is roughly 506,000. The Internet penetration rate among larger
SMEs is 12%, roughly in line with personal Internet penetration rate of 12.2% (or
162 million).
We do not think the market is saturated
Based on Baidu’s 2Q07 active marketing customers of 128,000, the company’s
penetration among larger SMEs is 2.9%. Hence, we believe the market is far from
reaching saturation point.
110
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
50% of corporate websites get fewer than 50 page views per day
According to the CNNIC survey, about 50% of all corporate websites in China have
fewer than 50 page views per day. With a low hit rate, we believe corporates would
use the search engine market (both search engine optimization and paid search) to
increase traffic to their sites and as a result generate new business leads.
Figure 81: China—Number of SMEs by different segments
500 k
SME with
websites
4.3 million
Larger-size
SME
20 - 42 million
Individual
businesses
Source: SAIC, JPMorgan estimates.
Ecommerce should be another growth driver
We expect C-C eCommerce to see better adoption in the next few years driven by
factors such as: (1) better acceptance for “mail order” (China’s catalogue sales are
non-existent, and most transactions are done faceto-face) through increased
marketing, more variety, and increased adoption of home TV shopping networks, (2)
improved trust and safety features by eCommerce sites, and (3) more regulated
online payment infrastructure.
In the US, eCommerce companies are leading users of paid search advertising. We
believe a similar trend will emerge in China, too, as paid search is an effective
method to target prospective buyers who already have items in mind. Currently,
leading online search advertisers in China include Alibaba, Taobao, Dangdang, Joyo,
Ctrip, and eLong. Given the expected higher growth in eCommerce, we expect paid
search to benefit from this growth.
Local search: Another promising area
Similar to the US, we believe there is a large commercial potential for local search in
China. Particularly, there are a large number of households/individual businesses
eager to promote their local businesses. In addition, IP address assignment is quite
well organized in China. We expect IP-based marketing to be more popular going
forward as online advertisers are more sophisticated.
111
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
IT outsourcing companies are the main educators for search usage
The two types of companies that help drive paid search usage of SMEs are ad
agencies and IT outsourcing companies. While ad agencies mainly focus on
companies that already have websites, IT outsourcing companies target SMEs that
are less sophisticated in IT infrastructure.
IT outsourcing companies such as Sino-I (250.HK), and Hichina (net.cn), provide
one-stop services for SMEs—domain name registration, web hosting, website
design, promotions (mainly through search engine optimization (SEO), paid search,
directory listing). We believe the IT outsourcing companies will be key players in the
future to drive Internet adoption growth and search usage for SMEs.
China Enterprise (ce.net) (fully owned by Sino-I) is one of the first official agents for
Google in China. It has approximately 220,000 customers. The company is a
dedicated educator for IT services in China with each of its 77 offices conducting
regular meetings for entrepreneurs and SMEs. We believe this kind of education will
help expand the number of advertisers for online search services.
Ad agencies would have to drive search market growth
Paid search marketing campaigns are usually more involved than display ads.
Advertisers need to decide on what keywords to use, the number of keywords,
bidding strategy and bidding period. In addition, more sophisticated advertisers also
pay attention to competitors’ strategy, lead quality and ROI. A well-run search
campaign is arguably more difficult than banner ads where advertisers simply design
the banners and place them on as many relevant websites as possible.
Furthermore, budgets for search campaigns are more difficult to manage as spending
is based on the number of clicks, which non-experienced advertisers do not have
control over. The ad spending amount essentially has no limit. Hence, advertisers are
generally quite cautious about the initial spending and only allocate a small daily
budget for trial, or even worse, just give up on paid search campaigns. We believe
education by agents and distributors can eventually help advertisers overcome these
barriers, and advertisers will thus increase their budgets on search campaigns.
Search market outlook: Monetization
We expect monetization of the paid search market to grow quickly driven by both
higher search usage by users and better adoption by advertisers. The coverage ratio is
low compared with the US, and we expect it to increase and drive monetization of
the market.
Self-fueling cycle to expand monetization
We view the market as a self-fueling cycle driven by user and advertiser growth.
Higher search usage typically leads to a higher number of sales leads for advertisers.
With more high-quality leads coming from paid search, advertisers would place more
keywords in more search engines. As users find more relevant product information
by advertisers, they likely will conduct more searches, thus leading to higher usage.
This cycle should continue and lead to market-size expansion.
112
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Selling channel comparison
Baidu: Mixed distribution strategy
In top cities, such as Beijing, Shanghai, and in the Dongguan/Guandong province
area, Baidu builds up its in-house sales force to distribute its own products. In most
other cities, it uses distributors to sell products. The company has a mixed strategy in
Shenzhen, where it has its own sales office and distributor. Typically, Baidu only
grants exclusive rights to one distributor in each geographic area.
Distributor discount
We believe Baidu gives distributors discounts of around 30%-40%, lower than other
search engines (such as Sogou and Zhongsou), which give discounts of 40%-50%.
We believe agents accept this lower discount because Baidu generates a higher
number of clicks, and as such higher absolute revenue.
Google: Distribution strategy still uncertain
From mid-2005 to late-2006, Google has signed roughly 20 authorized resellers in
China. However, we believe that some of these distributors have ended their
partnerships with Google. The main reason is the low distributor discount. We
believe Google only offers less than 10% of profits to distributors vs. roughly 30%
by Baidu.
Google, in our opinion, faces a dilemma. If the company offers larger discounts in
China, advertisers in other countries may place their ads through distributors in
China, and potentially obtain a discount, therefore, impacting Google’s revenue. We
also believe that Google’s distribution is still significantly behind Baidu in terms of
penetration.
Yahoo!
While the Alibaba group has an internal sales force of over 3,500 across the country,
Yahoo! search mainly relies on third-party distributors.
Sohu
Sohu also uses distributors for its search products. Distributors are typically
exclusive for each region.
Search market outlook: Key Issues with segment growth
Fraudulent clicks and trust issue to weigh on industry growth
Although not addressed in detail by industry players, we believe fraudulent clicks are
a significant problem. Parties that could benefit from fraudulent clicks are value
chain players—search engine companies, search partner sites, distributors, and
agencies -- as more clicks could translate into more commissions or advertising fees.
Table 61: Search ad buyers’ attitude to invalid clicks (click-fraud + accidental clicks) issue
Issues
Invalid click issue is not a significant concern
Invalid click rate is within acceptable limit
It's OK if ROI is OK
Invalid click rate is too high and discouraging
I am not aware of invalid clicks
Sum
% of Respondents
3%
28%
23%
39%
6%
100%
Source: China IntelliConsulting (CIC).
113
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Unethical practices by ad agencies remain a risk
As most search advertisers turn to agents to manage their ad campaigns, agents have
full access to advertisers’ accounts. It is not uncommon for some ad agencies to
deceive advertiser clients (as per search ad buyer surveys) by, for example,
increasing the bid price for keywords or adding some unrelated high-price keywords
(and receiving monetary benefits from search partner sites or search engines), or
even colluding in fraudulent clicks (as previously mentioned). Despite this industrywide issue, advertisers continue to place ads on search sites, which we believe
demonstrates that search advertising provides a reasonable ROI (return on
investment) despite fraudulent click issues. Nonetheless, we believe unethical
practices by ad agencies remain a risk to healthy long-term growth of the search
advertising market in China.
Regulatory Risks
Search companies are in an interesting position. On one hand, search engines try to
index as much information as possible, on the other hand, some of these materials
may be deemed to be politically sensitive. We believe Chinese Internet companies in
general are cautious about the issue, and avoid keywords/results content that could be
sensitive. We believe this political risk has existed since the beginning of the Internet
in China 10 years ago, and none of the major websites were closed because of it (the
only widely mentioned incident was the Google site being blocked in China in 2002).
Hence, we do not believe the political risk is high. We also do not expect search
companies’ revenue growth to be affected by politically sensitive content, as they are
difficult to commercialize, and we believe search companies have no interest in
including them in search results.
114
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Online Gaming
Robust growth outlook for online gaming
The online gaming sector witnessed revenue acceleration in 2007, with 55% YoY
growth, and reached ~US$1.33 billion, as per our estimates. The MMORPG segment
(~85% of total gaming market) grew 54% YoY to reach ~US$1.12 billion in 2007, as
per our estimates, with the success of the free-to-play (item-based sales) model being
among the key factors. The casual game segment, meanwhile, grew 56% YoY to
reach ~US$206 million in 2007.
For 2008, we forecast ~37% YoY growth in the MMORPG segment and ~43% YoY
growth in casual games. With more game companies having listed in 2H07, we
expect leaders and laggards to emerge. We maintain Shanda (leading free-to-play
game operator, strong operating and marketing capabilities and healthy game
pipeline) as our top pick in the gaming sector.
Table 62: China MMORPG Market Forecast
MMORPG gamers (million)
Internet users (million)
Game users penetration
Average ARPU per month (RMB)
Market size (RMB million)
MMORPG Market size (US$M)
Growth Rate:
2005
18.9
111.0
17.0%
21.7
4,918
592
35%
2006
24.6
137.0
17.9%
20.5
6,043
728
23%
2007E
34.4
175.0
19.7%
20.7
8,544
1,124
54%
2008E
44.7
200.3
22.3%
21.7
11,663
1,535
37%
2009E
55.9
220.8
25.3%
22.4
15,016
1,976
29%
2010E
66.0
238.8
27.6%
22.8
18,073
2,378
20%
2011E
75.9
258.3
29.4%
23.3
21,200
2,789
17%
Source: iResearch, JPMorgan estimates.
Table 63: China Casual Game Market Forecast
Casual game players (million)
Internet Users (million)
Casual players penetration
Assumed Ratio of paying users
APRU per month (Rmb)
Market size (RMB million)
Casual Market size (US$M)
Growth Rate:
2005
24.4
111.0
22.0%
22%
11.0
708
85
82%
2006
32.6
137.0
23.8%
23%
11.6
1,044
132
54%
2007E
42.4
175.0
24.2%
25%
12.2
1,563
206
56%
2008E
50.9
200.3
25.4%
27%
13.5
2,227
293
43%
2009E
59.0
220.8
26.7%
29%
14.5
2,996
394
35%
2010E
66.1
238.8
27.7%
30%
15.6
3,714
489
24%
2011E
71.4
258.3
27.6%
31%
16.7
4,435
584
19%
Source: iResearch, JPMorgan estimates.
Key industry drivers
We expect continued robust growth of online gaming in China to be driven by:
(1) Continued strong Internet user growth in China (‘06-‘10E CAGR of 15%).
(2) Upside in gamer penetration, which is still <25% (as % of Internet users); less
than half of Korea’s (also below HK and Taiwan); additional gamers particularly
from lower-tier cities.
(3) Increasing broadband penetration, with 122 million broadband Internet users as of
Jun-07, or 75% of total Internet users; CAGR of ~100% over last 5 years.
(4) Efforts of game companies - better quality, innovative games and more effective
promotions to continue to attract players; also, success of the free-to-play (item115
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
based sales) model (contributing ~63% of industry revenues in 2007, up from ~52%
in 2006, as per IDC estimates).
(5) Limited leisure alternatives - teenagers in first-tier China cities spending more on
entertainment like Internet/games, with the trend being replicated in smaller cities.
Good understanding of gamers’ needs will be a key
success factor for companies
Competition within the online gaming industry increased in 2007, with more free
games, more competitors, and further public listings (significant capital raised via
IPOs in 2H07). With the continuing popularity of the free-to-play model, we believe
game companies can continue to generate revenue growth as long as gamers believe
it is really “worth it.” Thus, we expect game companies that continue to maintain a
good understanding of what gamers will pay for (or strong marketing capabilities),
and respond accordingly, to see greater success going forward. Hence, in our view,
companies like Shanda (leading free-to-play game operator with strong operating and
marketing capabilities) are more likely to capitalize on the robust industry growth.
Comparison of leading games and game companies
Table 64: Leading MMORPG Companies by Revenue Market Share
2006
22%
31%
7%
17%
2%
4%
3%
14%
Shanda
NetEase
Giant Interactive
The9
Perfect World
CDC Games
Kingsoft
Others
9M07
24%
23%
18%
14%
6%
4%
4%
8%
Source: Company reports, JPMorgan estimates.
Table 65: Leading MMORPGs by PCU (Peak Concurrent Users)
(PCU in ‘000s)
Fantasy WWJ (NetEase)
Sequential growth
ZT Online (Giant)
Sequential growth
WoW (The9)
Sequential growth
WWJ2 (NetEase)
Sequential growth
Eudemons Online (NetDragon)
Sequential growth
Yulgang (CDC Games)
Sequential growth
Source: Company reports.
116
1Q06
1,236
18.5%
120
610
15.1%
581
4.8%
26
330
26.9%
2Q06
1,313
6.2%
320
166.7%
630
3.3%
562
-3.3%
50
92.3%
348
5.5%
3Q06
1,223
-6.9%
558
74.4%
595
-5.6%
593
5.5%
128
156.0%
331
-4.9%
4Q06
1,335
9.2%
755
35.3%
680
14.3%
603
1.7%
325
153.9%
333
0.5%
1Q07
1,503
12.5%
874
15.8%
680
0.0%
480
-20.4%
438
34.8%
343
3.2%
2Q07
1,472
-2.1%
1,073
22.7%
665
-2.2%
505
5.3%
496
13.2%
na
3Q07
1,443
-1.9%
888
-17.2%
809
21.7%
305
-39.7%
527
6.3%
na
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 66: Leaders in MMOG Active Paying Accounts (Free-to-play Model)
(In ‘000s)
Shanda
Sequential growth
Giant Interactive
Sequential growth
Perfect World
Sequential growth
Sohu
Sequential growth
The9
Sequential growth
1Q06
2,470
143
2Q06
2,230
-9.7%
602
321.0%
3Q06
2,140
-4.0%
698
15.9%
26
4Q06
2,290
7.0%
787
12.8%
602
2215%
1Q07
2,340
2.2%
986
25.3%
695
15.4%
2Q07
2,720
16.2%
1,248
26.6%
1,040
49.6%
209
4
194
4995%
3Q07
3,080
13.2%
1,318
5.6%
1,390
33.7%
690
230.1%
183
-5.3%
Source: Company reports, JPMorgan estimates. Note: Perfect World: based on item-based games; Sohu: based on TLBB; The9:
based on SUN and JJW.
Table 67: Leaders in MMOG Quarterly ARPU per Active Paying Account (Free-to-play Model)
(In Rmb)
Giant Interactive
Sequential growth
Shanda
Sequential growth
Perfect World
Sequential growth
Sohu
Sequential growth
The9
Sequential growth
1Q06
84
91
2Q06
117
39.3%
137
49.7%
3Q06
220
88.0%
155
13.4%
12
4Q06
220
0.0%
165
6.8%
76
544.9%
1Q07
320
45.5%
177
7.1%
95
25.2%
2Q07
295
-7.8%
174
-1.9%
98
2.8%
171
88
85
-3.4%
3Q07
305
3.5%
179
3.1%
136
38.8%
118
-30.8%
175
105.4%
Source: Company reports, JPMorgan estimates. Note: Perfect World: based on item-based games; Sohu: based on TLBB; The9:
based on SUN and JJW.
117
Imran Khan
(1-212) 622-6693
[email protected]
118
North America Equity Research
02 January 2008
U.S. Company Previews
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Amazon.com, Neutral ($92.85)
We are maintaining our Neutral rating on Amazon. Although we have been
impressed with the company’s ability to generate above-market revenue growth
despite its size, we believe the stock’s valuation leaves limited room for upside.
•
Third-party sales growth to offset margin pressure from pricing. As a
percentage of units, the company saw third-party sales increase more than
200 bps Y/Y in the first three quarters of ’07. We believe third-party as a %
of sales is likely to continue growing in F’08. Further, we believe the
platform helps Amazon expand selection, which ranked as the #2 factor
influencing shoppers’ site choices in our proprietary survey. We think the
more profitable 3P business should help offset margin pressure resulting
from the site’s continued competitiveness in the #1 factor, price. As such,
we are modeling flat gross margins in F’08, at 22.9%.
•
Slight improvement in operating margins. We are modeling F’08
operating margin improvement of ~30 bps and F’09 improvement of ~20
bps, partly due to our expectation of increased leverage in expense lines
such as tech & content as the company grows. We do not expect any
leverage on gross margins, as we expect Amazon will continue to offer
discounts to spur continued US sales growth. Additionally, we do not expect
material leverage from fulfillment, as the company invests to support sales
growth.
•
2008 drivers. In our view, the following factors will drive the stock in
2008: (1) Amazon’s continued ability to outperform the eCommerce
market’s growth rate; (2) the competitiveness of online offerings from
brick-and-mortar retailers; (3) third-party sales mix; (4) potential for tech &
content leverage. Additionally, the broader state of consumer spending is
likely to have a continued impact on Amazon.
•
Maintaining 4Q and 2007 estimates. We remain comfortable with our 4Q
revenue, GAAP operating income and EPS estimates of $5.3B, $273M and
$0.46. For the full year, we expect revenue, GAAP operating income and
EPS of $14.5B, $657M, and $1.10.
Table 68: Amazon Estimates Snapshot
$ in millions, except per share data
AMZN
4Q'07E
F'07E
F'08E
F'09E
F'07E
Y/Y
F'08E
F'09E
JPM
Revenue
EBITDA
EPS
5,325
392
0.46
14,488
1,093
$1.10
17,938
1,474
$1.51
21,269
2,178
$1.87
35.3%
84.0%
144.2%
23.8%
34.8%
37.2%
18.6%
47.8%
23.8%
Consensus
Revenue
EBITDA
EPS
5,360
393
0.48
14,504
1,080
1.12
18,256
1,446
1.61
22,373
1,884
2.41
35.4%
81.8%
148.6%
25.9%
33.9%
44.2%
22.5%
30.3%
49.2%
Source: Company reports, FactSet, JPMorgan estimates
121
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
We See Slight Margin Expansion in F’08 and F'09
We think Amazon is poised to continue to benefit from improved leverage across its
operating expense lines in the coming years. We think increased scale is likely to
help the company boost its operating margins, up 30 bps in F’08 and up ~20 bps in
F’09, to 6.3%.
Table 69: Key Expense metrics for Amazon.com
Fulfillment
Marketing
Technology and content
General and administrative
Y/Y Change in:
Revenue growth
Fulfillment
Marketing
Technology and content
General and administrative
Operating Margin (pro forma)
2006
8.5%
2.4%
5.7%
1.6%
2007E
8.4%
2.2%
5.0%
1.4%
2008E
8.3%
2.2%
4.8%
1.4%
2009E
8.2%
2.2%
4.7%
1.3%
26%
5 bps
-14 bps
-88 bps
8 bps
-204 bps
35%
8 bps
19 bps
69 bps
27 bps
123 bps
24%
11 bps
1 bps
16 bps
2 bps
30 bps
19%
11 bps
3 bps
8 bps
2 bps
18 bps
Source: Company reports, JPMorgan estimates
Our Estimates and Outlook for 2008
We believe Amazon’s F’08 North America sales are likely to slow their pace of
growth from the rapid growth exhibited in F’07, with a slightly softer economic
outlook likely to cut into retail sales, as well as tougher comps due to the absence of
Harry Potter. We are modeling 23% NA sales growth in F’08. Internationally, we
expect the company to grow slightly faster, at 25%. International sales should
continue to benefit from favorable Y/Y FX rates (even assuming no further
weakening of the dollar).
We now expect Amazon F’08 revenue of $17.9B, up from $17.4B previously, and
we continue to project a 22.9% gross margin. We expect gross margins to see
roughly offsetting impact from higher third-party sales on the one hand and more
aggressive product pricing, on the other. We are projecting GAAP operating income
of $881M, from $844M previously, and EPS of $1.51, up from $1.45, with the
upside driven by our higher revenue projections, as we continue to expect the
company to post a 6.1% pro forma operating margin.
Our Estimates and Outlook for 2009
For F’09, we expect revenue growth to continue to moderate somewhat, as the
company drives benefits from better scale and slight improvements in profitability.
We are forecasting 19% overall revenue growth, to $21.3B, and slight Y/Y erosion in
gross margin, to 22.8%. We are modeling F’09 GAAP operating income of $1.1B,
and EPS of $1.87.
Valuation and Rating Analysis
AMZN trades at a premium to its peers. Our F’07 assumptions yield a 2007
EV/EBITDA multiple of 35.9x our F’07 EBITDA estimate of $1,093M, versus the
ecommerce group at 28.2x. AMZN trades at 26.7x our F’08 EBITDA estimate of
$1,437M, versus the ecommerce group at 19.1x. Despite strong EBITDA growth in
both F'07 and F'08, we believe that AMZN shares are fully valued.
122
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
AMZN could outperform if the company is able to successfully expand its third-party
relationships faster than we are forecasting, in which case our margin assumptions
could be too conservative. Additionally, an ever-growing portion of Amazon’s
revenue is from its international business, exposing the company to foreign currency
fluctuations.
AMZN could underperform if it encounters difficulties in its international expansion,
including regulatory hurdles that make the business climate less hospitable and
potentially less profitable than the markets where it currently operates. Amazon may
have difficulty growing revenues while maintaining its current operating margins.
123
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 70: AMZN Annual Income Statement
$ in millions, except per share data
FY
2006
10,711
8,256
2,455
22.9%
FY
2007E
14,488
11,172
3,316
22.9%
FY
2008E
17,938
13,826
4,111
22.9%
FY
2009E
21,269
16,410
4,859
22.8%
Fulfillment
Marketing
Technology and content
General and administrative
Other operating expense (income)
Stock-based compensation (1)
Amortization of other intangibles
Restructuring-related and other
Total operating expenses
Total recurring operating expenses
912
259
607
176
10
101
2,065
1,964
1,223
323
721
198
9
185
2,659
2,474
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
390
491
3.6%
4.6%
657
842
4.5%
5.8%
1,473
399
873
254
16
216
3,231
3,015
881
1,097
4.9%
6.1%
1,747
466
1,007
284
16
240
3,760
3,520
1,099
1,339
5.2%
6.3%
EBITDA
702
1,093
1,474
2,178
Income (loss) from continuing operations
Interest Income
Interest Expense
Other Income, net
Total non-operating expenses, net
Income (loss) before equity in losses of equity-method investees
Income (loss) before change in accounting principle (reported)
491
60
(80)
(3)
(23)
468
468
842
81
(75)
(2)
4
846
846
Cumulative effect of change in accounting principle
GAAP Income before taxes
Tax Rate
Provision (benefit) for taxes
Net income (loss)
Remeasurement of 6.875% PEACS and other
Other gains (losses), net
Total Extraordinary Items
Net income (loss) Reported
377
49.6%
187
281
10
10
190
652
29.0%
189
657
(9)
(9)
463
1,097
89
(64)
25
1,122
1,122
906
29.0%
263
859
643
1,339
89
(64)
25
1,364
1,364
1,124
29.0%
326
1,038
798
GAAP EPS
$0.45
$1.10
$1.51
$1.87
425
423
426
428
% Of Revenue
Fulfillment
Marketing
Technology and content
General and administrative
8.5%
2.4%
5.7%
1.6%
8.4%
2.2%
5.0%
1.4%
8.2%
2.2%
4.9%
1.4%
8.2%
2.2%
4.7%
1.3%
Y/Y Change
Revenue
Fulfillment
Marketing
Technology and content
General and administrative
PF Operating Income
26%
25%
34%
50%
21%
-13%
35%
34%
25%
19%
13%
72%
24%
20%
23%
21%
28%
30%
19%
19%
17%
15%
12%
22%
Net sales
Cost of sales
Gross profit
Gross Margins
Shares Outstanding
Source: Company reports and JPMorgan estimates.
124
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 71: AMZN Quarterly Income Statement
$ in millions, except per share data
Net sales
Cost of sales
Gross profit
Gross Margins
Fulfillment
Marketing
Technology and content
General and administrative
Other operating expense (income)
Stock-based compensation (1)
Amortization of other intangibles
Restructuring-related and other
Total operating expenses
Total recurring operating expenses
Q1-06
2,279
1,732
547
24.0%
FY 2006
Q2-06
Q3-06
2,139
2,307
1,630
1,758
509
549
23.8%
23.8%
Q4-06
3,986
3,136
850
21.3%
Q1-07
3,015
2,296
719
23.8%
FY 2007E
Q2-07
Q3-07
2,886
3,262
2,185
2,500
701
762
24.3%
23.4%
Q4-07E
5,325
4,191
1,134
21.3%
Q1-08E
3,864
2,944
920
23.8%
FY 2008E
Q2-08E
Q3-08E
3,601
3,910
2,726
2,971
875
938
24.3%
24.0%
Q4-08E
6,563
5,185
1,378
21.0%
190
54
138
45
3
11
-
182
52
151
44
3
30
-
209
63
156
49
2
30
-
331
90
162
38
2
30
-
253
71
167
49
34
-
248
63
176
49
3
46
-
285
72
181
47
3
51
-
437
117
197
53
3
54
-
313
89
205
62
4
54
-
299
82
216
58
4
54
-
336
90
223
59
4
54
-
525
138
230
75
4
54
-
441
430
462
432
509
479
653
623
574
540
585
539
639
588
861
807
726
672
712
658
766
712
1,026
972
106
117
4.7%
5.1%
47
77
2.2%
3.6%
40
70
1.7%
3.0%
197
227
4.9%
5.7%
145
179
4.8%
5.9%
116
162
4.0%
5.6%
123
174
3.8%
5.3%
273
327
5.1%
6.1%
193
247
5.0%
6.4%
163
217
4.5%
6.0%
173
227
4.4%
5.8%
352
406
5.4%
6.2%
EBITDA
160
123
133
286
241
225
235
392
193
433
329
518
Income (loss) from continuing operations
Interest Income
Interest Expense
Other Income, net
Total non-operating expenses, net
Income (loss) before equity in losses of equity-method investees
Income (loss) before change in accounting principle (reported)
117
15
(21)
(1)
(7)
110
110
77
13
(19)
1
(5)
72
72
70
14
(21)
4
(3)
67
67
227
18
(19)
(7)
(8)
219
219
179
20
(19)
1
180
180
162
20
(19)
(1)
162
162
174
23
(19)
(1)
3
177
177
327
18
(18)
247
20
(16)
217
20
(16)
227
29
(16)
406
20
(16)
327
327
4
251
251
4
221
221
13
240
240
4
410
410
Cumulative effect of change in accounting principle
GAAP Income before taxes
Tax Rate
Provision (benefit) for taxes
Net income (loss)
Remeasurement of 6.875% PEACS and other
Other gains (losses), net
Total Extraordinary Items
Net income (loss) Reported
96
46.9%
45
65
(3)
(3)
51
54
59.3%
32
40
12
12
22
38
49.6%
19
48
1
1
19
189
48.1%
91
128
98
144
22.9%
33
147
(2)
(2)
111
111
29.7%
33
129
(5)
(5)
78
124
35.5%
44
133
(2)
(2)
80
273
29.0%
79
248
194
197
29.0%
57
194
140
167
29.0%
48
172
118
186
29.0%
54
186
132
356
29.0%
103
307
253
GAAP EPS
$0.12
$0.05
0.05
$0.23
$0.26
$0.19
$0.19
$0.46
$0.33
$0.28
$0.31
$0.59
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
125
Imran Khan
(1-212) 622-6693
[email protected]
Shares Outstanding
North America Equity Research
02 January 2008
Q1-06
426
FY 2006
Q2-06
Q3-06
426
424
Q4-06
422
Q1-07
420
FY 2007E
Q2-07
Q3-07
423
425
Q4-07E
425
Q1-08E
426
FY 2008E
Q2-08E
Q3-08E
426
426
Q4-08E
427
% Of Revenue
Fulfillment
Marketing
Technology and content
General and administrative
8.3%
2.4%
6.1%
2.0%
8.5%
2.4%
7.1%
2.1%
9.1%
2.7%
6.8%
2.1%
8.3%
2.3%
4.1%
1.0%
8.4%
2.4%
5.5%
1.6%
8.6%
2.2%
6.1%
1.7%
8.7%
2.2%
5.5%
1.4%
8.2%
2.2%
3.7%
1.0%
8.1%
2.3%
5.3%
1.6%
8.3%
2.3%
6.0%
1.6%
8.6%
2.3%
5.7%
1.5%
8.0%
2.1%
3.5%
1.2%
Q/Q Change
Revenue
Fulfillment
Marketing
Technology and content
General and administrative
PF Operating Income
PF Net Income
-23%
-23%
-19%
12%
-2%
-35%
-69%
-6%
-4%
-4%
9%
-2%
-34%
-38%
8%
15%
21%
3%
11%
-9%
21%
73%
58%
43%
4%
-22%
224%
165%
-24%
-24%
-21%
3%
29%
-21%
15%
-4%
-2%
-11%
5%
0%
-9%
-12%
13%
15%
14%
3%
-4%
7%
3%
63%
53%
63%
9%
13%
88%
86%
-27%
-28%
-24%
4%
16%
-24%
-22%
-7%
-5%
-8%
5%
-7%
-12%
-11%
9%
13%
10%
3%
2%
5%
8%
68%
56%
53%
3%
29%
79%
65%
Y/Y Change
Revenue
Fulfillment
Marketing
Technology and content
General and administrative
PF Operating Income
20%
17%
23%
68%
7%
-9%
22%
19%
30%
62%
38%
-42%
24%
26%
50%
44%
88%
-42%
34%
35%
34%
32%
-17%
25%
32%
33%
31%
21%
9%
53%
35%
36%
21%
17%
11%
110%
41%
36%
14%
16%
-4%
149%
34%
32%
30%
22%
40%
44%
28%
24%
25%
23%
26%
38%
25%
21%
30%
23%
18%
34%
20%
18%
25%
23%
25%
30%
23%
20%
18%
17%
42%
24%
Additional Revenue
Operating profit
Contribution Margins
377
(11)
-3%
386
(55)
-14%
449
(51)
-11%
1,009
46
5%
736
62
8%
747
85
11%
955
104
11%
1,339
100
7%
849
68
8%
715
55
8%
648
53
8%
1,238
79
6%
Source: Company reports and JPMorgan estimates.
126
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 72: AMZN Annual Balance Sheet
$ in millions
ASSETS:
Cash/Equivalents
ST Investments
Inventories
A/R, net and other current
Total Current Assets
Equipment, Net
Other LT Assets
L.T. Investments
Goodwill/Intang.
Goodwill
Total Other Assets
Total Assets
LIABILITIES:
Accounts Payable
Accrued Expense
Unearned Revenue
Oth. Curr. Liab.
Curr.Port.LT Debt
Advertising
Total Current Liabs
FY-06
FY-07E
FY-08E
FY-09E
1022.0
997.0
877.0
477.0
3373.0
2610.3
543.0
1224.8
639.0
5017.1
4315.2
543.0
1575.2
787.6
7221.0
6396.9
543.0
1861.6
930.8
9732.3
457.0
139.0
199.0
0.0
195.0
990.0
510.0
254.0
218.0
0.0
231.0
1213.0
584.0
254.0
218.0
0.0
231.0
1287.0
682.0
254.0
218.0
0.0
231.0
1385.0
4363.0
6230.1
8508.0
11117.3
1816.0
716.0
0.0
0.0
0.0
2396.4
798.8
0.0
0.0
0.0
2532.0
3195.2
2953.5
984.5
0.0
0.0
0.0
0.0
3938.0
3490.6
1163.5
0.0
0.0
0.0
0.0
4654.1
1538.0
0.0
1538.0
Long Term Debt
Capital Leases
Total Long Term Debt
1400.0
1538.0
1400.0
1538.0
1538.0
0.0
1538.0
Total Liabilities
3932.0
4733.2
5476.0
6192.1
431.0
1497.0
3032.0
4925.3
4363.0
6230.1
8508.0
11117.3
SHAREHOLDER EQUITY:
Total Equity
Liabilities + Equity
Source: Company reports and JPMorgan estimates.
127
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 73: AMZN Annual Cash Flow Statement
$ in millions
FY-06
OPERATING CASH FLOWS
Net Income
Depreciation and amortization
Stock-Based Amort.
Other operating expense
Excess tax benefit on stock awards
Equity in Loss
Amort. Intangibles
Merger/Acquisition
Mrktbl.Secs.
Remeasurement and other
Investment Inc/Loss
Interest Expense
Accounting Change
Deferred Taxes
Changes current assets
Inventories
Prepaid Exp./Other
Accounts Payable
Accrued Expense
Other Operating
Non-Cash Items
Interest Payable
Cash From Operations
FCF
Y/Y Growth
INVESTING CASH FLOWS
Mat./ST Investments
Purch./ST Investment
Capital Expenditures
Sale of Subsidiary
Invst. in Affiliates
Acquisitions
Cash From Investing
FINANCING CASH FLOWS
Options Exercised
Tax benefit of stock awards
Issuance of Common
Options/Common Issue
Proceeds/LT Debt
Repay. LTD
Repayment of Debt
Financing Costs
Purch./Sale of Stock
Long Term Debt
Cash From Financing
Foreign Exch Effects
Net Change In Cash
Beginning Cash
Ending Cash
Source: Company reports and JPMorgan estimates.
128
FY-07E
FY-08E
FY-09E
190.3
205.0
101.0
462.9
248.0
185.0
643.0
300.0
216.0
-
798.2
338.0
232.0
-
2.0
6.0
(4.0)
3.0
-
3.0
3.0
23.0
245.0
-282.0
-103.0
402.0
203.0
158.0
(133.0)
701.3
(2.0)
755.9
(213.0)
62.9
582.8
297.3
121.0
(95.0)
1573.9
835.9
(347.8)
153.9
769.5
260.4
1994.9
1,043.6
(350.4)
182.6
904.0
307.3
2411.7
485.3
-8.5%
1350.9
178.4%
1704.9
26.2%
2081.7
22.1%
1,844.0
(1,929.0)
(216.00)
(32.0)
(333.0)
1,155.0
(777.0)
(223.0)
(47.0)
108.0
(290.0)
(290.0)
(330.0)
(330.0)
36.0
79.0
99.0
(70.0)
(313.0)
(252.0)
(399.0)
40.0
9.3
1,013.1
1,022.4
33.0
(58.0)
(17.0)
(248.0)
(118.0)
24.0
1,587.9
1,022.4
2,610.3
1,704.9
2,610.3
4,315.2
2,081.7
4,315.2
6,396.9
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Blue Nile, Neutral ($74.16)
We think that NILE will continue to experience both strong revenue growth and
margin expansion in F’08. We believe that engagement products are less
discretionary than other jewelry purchases and that the company’s value-driven
model will be attractive to customers in a weak economy. However, we think that, at
the stock’s current valuation, NILE will likely trade in line with its peer group.
Hence, we reiterate our Neutral rating.
• Gains in traffic and number of purchases likely to continue. Traffic growth
accelerated to 20% Y/Y in 3Q’07, the highest third-quarter traffic growth since
2004. We believe that traffic gains are sustainable as the company pursues
efficient and targeted marketing, as online shopping penetration rises, and as
consumers become more value-oriented in a weak economy. Furthermore, we
believe that repeat business accounts for only slightly over 20% of revenue and
non-diamond jewelry for ~10%. Given NILE’s high customer satisfaction levels,
we believe repeat purchases will continue to climb.
• We think international market development will be a priority. At the end of
3Q’07, int’l revenues were only ~7% of total revenue. This is markedly lower
than other e-commerce companies such as Amazon and eBay where int’l revenue
accounts for ~45% and ~51%, respectively. With the opening of the Ireland
operations center, the launch of localized websites in Canada and the UK,
planned product introductions, and a more integrated marketing program within
the next 1-2 years, we believe int'l markets will be a large growth driver in 2008
and 2009.
• 2008 Drivers. In our view, the following factors will drive NILE shares in 2008:
(1) top-line strength from discounted diamond pricing, (2) increased focus on
int’l markets, and (3) operating margin expansion from increased leverage.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $114.3M, $12.8M, and $0.44 (Y/Y growth of 26%, 32%, and
27% respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 74: Blue Nile Estimates Snapshot
$ in millions, except per share data
Blue Nile
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
114.32
12.80
0.44
321.68
30.42
1.03
388.45
36.20
1.23
453.79
43.83
1.50
27.9%
35.7%
14.1%
20.8%
19.0%
19.0%
16.8%
21.1%
22.1%
113.52
12.53
0.44
321.10
29.27
1.04
391.43
36.25
1.30
464.01
45.70
1.63
21.9%
23.8%
25.0%
18.5%
26.1%
25.4%
Source: JPMorgan estimates, Company data, and Bloomberg
129
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
Our updated 2008 estimates call for Y/Y revenue, EBITDA, and EPS growth of
20.8%, 19.0%, and 19.0%, respectively. Specifically, we are modeling 2008
revenues, EBITDA, and GAAP EPS of $388.5M, $36.2M, and $1.23 (from
$384.0M, $36.8M, and $1.22).
We believe that the company will intensify its focus on international efforts in 2008,
with an emphasis on its UK and Canadian websites. We believe that management
has been encouraged with the early response to the sites and will now invest more
heavily in growing these ventures. With the opening of the Ireland operations center,
the launch of localized websites in Canada and the UK, planned product
introductions, and a more integrated marketing program within the next 1-2 years, we
believe int'l markets will be a more significant growth driver in 2008.
Our Estimates and Outlook for 2009
Our newly introduced 2009 estimates call for revenue, EBITDA, and EPS growth of
16.8%, 21.1%, and 22.1%, respectively. Specifically, we are modeling 2009
revenues, EBITDA, and GAAP EPS of $453.8M, $43.8M, and $1.50.
We expect top-line growth to continue to be driven by international expansion and
believe that the company might start to look at markets outside the UK and Canada.
In addition, we expect operating margins to continue to expand due to increased
leverage as we believe many of the existing assets can be used to support
international expansion.
Valuation and Rating Analysis
On a P/E basis, NILE trades at 60.4x our F’08 GAAP EPS estimate of $1.22 vs. its ecommerce peers, which trade at 38.1x F’08 estimates. We do not think there is
additional multiple expansion opportunity at this time and we maintain our Neutral
rating.
Risks to Our Rating
Blue Nile is highly dependent on its diamond and jewelry suppliers, and it would be
difficult for the company’s business model to tolerate large price fluctuations in the
price to acquire diamonds and jewelry. Blue Nile faces competition from both offline
and online competitors, who operate in different spaces in the jewelry market. Online
competitors include: diamond.com, amazon.com, walmart.com, mondera.com, and
Ashford. Changes to Internet regulations regarding the collection of state and local
taxes could negatively impact Blue Nile’s business, as consumers save a significant
amount of money by purchasing jewelry over the Internet. A substantial number of
Blue Nile’s shares are owned by insiders, giving NILE management significant
voting leverage. Additionally, if the management decided to sell the stock then it
could create selling pressure on the stock. If the company successfully executes its
international business strategy or gains market share in the US from traditional
retailers, our estimate could prove to be too conservative.
130
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 75: NILE Annual Income Statement
$ in millions, except per share data
2006
2007E
2008E
2009E
Total Revenue
251.6
321.7
388.4
453.8
Cost of Revenue
Pro forma FAS123R adjustment
Pro forma Cost of Revs
200.7
256.2
309.0
360.4
200.7
256.2
309.0
360.4
Gross Profit (Rpt)
Gross Profit (Pforma)
Gross Margin (Rpt)
Gross Margins (PF)
50.9
50.9
20.2%
20.2%
65.4
65.4
20.3%
20.3%
79.4
79.4
20.4%
20.4%
93.4
93.4
20.6%
20.6%
SG&A
Restructuring
FAS 123R Stock based compensation
Total Expenses
Total Recurring Expenses
34.3
4.0
34.3
30.3
42.7
5.9
42.7
36.8
52.0
60.8
6.3
52.0
45.7
7.1
60.8
53.7
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
16.6
20.6
6.6%
8.2%
22.7
28.6
7.1%
8.9%
27.4
33.7
7.1%
8.7%
32.6
39.7
7.2%
8.8%
EBITDA
EBITDA Margin
Y/Y EBITDA Growth
22.4
8.9%
13.4%
30.4
9.5%
35.7%
36.2
9.3%
19.0%
43.8
9.7%
21.1%
Other Income (Expense)
Total Other
3.4
3.4
3.9
3.9
4.4
4.4
6.0
6.0
Income Before Taxes (Reported)
Income Before Taxes (Pro Forma)
20.0
24.1
26.6
32.5
31.8
38.1
38.6
45.7
Income Taxes (Rpt)
Income Taxes (Pforma)
Tax Rate
Pforma Tax Rate
Inc From Ops After Taxes (Rpt)
Inc From Ops After Taxes (PF)
6.9
8.4
34.5%
9.3
11.4
35.1%
11.2
13.4
35.2%
13.6
16.1
35.2%
13.1
15.7
17.3
21.1
20.6
24.7
25.0
29.6
-
-
13.1
15.7
17.3
21.1
20.6
24.7
25.0
29.6
% of Total Revenue
Cost of Revenue
Gross Profit
SG&A
0.76
0.90
17.3
0.14
15%
79.8%
20.2%
13.6%
1.03
1.26
16.7
0.23
36%
79.7%
20.3%
13.3%
1.23
1.47
16.8
0.24
19%
79.6%
20.4%
13.4%
1.50
1.78
16.7
0.28
22%
79.4%
20.6%
13.4%
Y/Y Change
Total Revenue
Cost of Revenue
SG&A
23.8%
27.0%
26.6%
27.9%
27.6%
24.5%
20.8%
20.6%
21.8%
16.8%
16.6%
16.9%
Extraordinary Item
Reported Net Income
Pro Forma Net Income
Reported EPS
Pro Forma EPS
Diluted Shares
Source: Company reports and JPMorgan estimates.
131
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 76: NILE Quarterly Income Statement
$ in millions, except per share data
Q1-06
Q2-06
Total Revenue
50.7
56.9
Cost of Revenue
Pro forma FAS123R adjustment
Pro forma Cost of Revs
40.3
0.0
40.3
FY 2006
Q3-06
FY 2007E
Q2-07
Q3-07
Q4-06
Q1-07
53.2
90.7
67.9
72.1
45.6
0.0
45.6
42.8
0.0
42.8
72.0
0.0
72.0
54.7
10.4
10.4
20.5%
20.5%
11.3
11.4
19.9%
20.0%
10.4
10.5
19.6%
19.6%
7.7
7.7
0.8
7.7
6.9
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
EBITDA
EBITDA Margin
Y/Y EBITDA Growth
FY 2008E
Q2-08E
Q3-08E
Q4-07E
Q1-08E
67.4
114.3
83.5
88.0
81.5
135.5
57.2
54.0
90.4
66.6
70.0
65.0
107.4
54.7
57.2
54.0
90.4
66.6
70.0
65.0
107.4
18.7
18.7
20.6%
20.6%
13.2
13.2
19.5%
19.5%
14.9
14.9
20.7%
20.7%
13.4
13.4
19.8%
19.8%
23.9
23.9
20.9%
20.9%
17.0
17.0
20.3%
20.3%
17.9
17.9
20.4%
20.4%
16.5
16.5
20.2%
20.2%
28.0
28.0
20.7%
20.7%
8.3
10.6
9.6
9.9
9.7
13.5
11.7
12.0
12.6
15.7
0.9
7.7
6.9
1.2
8.3
7.1
1.2
10.6
9.4
1.3
9.6
8.3
1.4
9.9
8.5
1.4
9.7
8.3
1.8
13.5
11.7
1.3
11.7
10.4
1.4
12.0
10.6
1.6
12.6
11.0
2.0
15.7
13.7
2.7
3.5
5.3%
6.9%
3.6
4.5
6.3%
7.9%
2.2
3.4
4.1%
6.3%
8.1
9.3
9.0%
10.3%
3.7
5.0
5.4%
7.3%
5.0
6.4
7.0%
8.9%
3.6
5.0
5.4%
7.4%
10.4
12.2
9.1%
10.7%
5.3
6.6
6.3%
7.9%
6.0
7.4
6.8%
8.4%
3.8
5.4
4.7%
6.7%
12.3
14.3
9.1%
10.6%
3.9
7.8%
-1.2%
5.0
8.7%
17.5%
3.8
7.2%
5.2%
9.7
10.7%
22.4%
5.4
7.9%
36.9%
6.8
9.5%
37.4%
5.4
8.0%
41.9%
12.8
11.2%
31.9%
7.2
8.6%
33.1%
8.0
9.1%
17.0%
6.0
7.4%
11.2%
15.0
11.1%
17.4%
Other Income (Expense)
Total Other
1.0
1.0
1.0
1.0
0.7
0.7
0.8
0.8
1.2
1.2
0.8
0.8
1.0
1.0
1.0
1.0
1.1
1.1
1.1
1.1
1.1
1.1
1.1
1.1
Income Before Taxes (Reported)
Income Before Taxes (Pro Forma)
3.7
4.5
4.6
5.5
2.8
4.0
8.9
10.1
4.9
6.2
5.8
7.2
4.6
6.0
11.4
13.2
6.4
7.7
7.1
8.5
4.9
6.5
13.4
15.4
Income Taxes (Rpt)
Income Taxes (Pforma)
Tax Rate
Pforma Tax Rate
Inc From Ops After Taxes (Rpt)
Inc From Ops After Taxes (PF)
1.3
1.6
35.5%
35.6%
2.4
2.9
1.5
1.8
31.7%
32.3%
3.1
3.7
1.0
1.4
35.6%
35.6%
1.8
2.6
3.2
3.6
35.5%
35.5%
5.8
6.5
1.7
2.2
34.9%
34.9%
3.2
4.0
2.1
2.6
35.4%
35.4%
3.8
4.7
1.6
2.1
35.0%
35.0%
3.0
3.9
4.0
4.6
35.0%
35.0%
7.4
8.6
2.2
2.7
35.2%
35.2%
4.1
5.0
2.5
3.0
35.2%
35.2%
4.6
5.5
1.7
2.3
35.2%
35.2%
3.2
4.2
4.7
5.4
35.2%
35.2%
8.7
10.0
2.4
3.1
1.8
5.8
3.2
3.8
3.0
7.4
4.1
4.6
3.2
8.7
Gross Profit (Rpt)
Gross Profit (Pforma)
Gross Margin (Rpt)
Gross Margins (PF)
SG&A
Restructuring
FAS 123R Stock based compensation
Total Expenses
Total Recurring Expenses
Q4-08E
Extraordinary Item
Reported Net Income
132
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Q1-06
2.9
Q2-06
3.7
0.13
0.16
18.2
0.18
0.21
17.6
% of Total Revenue
Cost of Revenue
Gross Profit
SG&A
79.5%
20.5%
15.2%
Q/Q change
Total Revenue
Cost of Revenue
SG&A
Y/Y Change
Total Revenue
Cost of Revenue
SG&A
Pro Forma Net Income
Reported EPS
Pro Forma EPS
Diluted Shares
FY 2006
Q3-06
2.6
FY 2007E
Q2-07
Q3-07
4.7
3.9
Q4-06
6.5
Q1-07
4.0
0.11
0.16
16.7
0.34
0.39
16.8
0.19
0.24
16.5
0.23
0.28
16.6
80.1%
19.9%
13.6%
80.4%
19.6%
15.5%
79.4%
20.6%
11.7%
80.5%
19.5%
14.1%
-30.8%
-29.3%
-11.8%
12.3%
13.0%
0.5%
-6.4%
-6.0%
6.8%
70.4%
68.2%
27.9%
14.9%
17.1%
25.8%
29.9%
34.7%
25.3%
26.8%
30.7%
36.7%
23.9%
26.3%
21.0%
FY 2008E
Q2-08E
Q3-08E
5.5
4.2
Q4-07E
8.6
Q1-08E
5.0
Q4-08E
10.0
0.18
0.23
16.9
0.44
0.51
16.9
0.24
0.29
16.9
0.27
0.33
16.9
0.19
0.25
16.7
0.52
0.60
16.7
79.3%
20.7%
13.7%
80.2%
19.8%
14.5%
79.1%
20.9%
11.8%
79.7%
20.3%
14.0%
79.6%
20.4%
13.6%
79.8%
20.2%
15.5%
79.3%
20.7%
11.6%
-25.2%
-24.1%
-9.6%
6.2%
4.6%
3.6%
-6.6%
-5.5%
-1.7%
69.7%
67.5%
38.4%
-26.9%
-26.4%
-13.3%
5.3%
5.2%
2.3%
-7.3%
-7.1%
5.6%
66.2%
65.2%
24.4%
34.0%
35.6%
24.1%
26.7%
25.4%
27.9%
26.5%
26.1%
17.8%
26.0%
25.5%
27.6%
23.0%
21.8%
22.3%
22.0%
22.5%
20.7%
21.0%
20.4%
29.6%
18.5%
18.8%
16.5%
Source: Company reports and JPMorgan estimates.
133
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 77: NILE Annual Balance Sheet
$ in millions
2006
2007E
2008E
2009E
78.5
0.1
19.8
1.6
14.6
0.6
0.7
116.0
135.3
2.2
18.3
0.7
4.1
160.7
192.0
2.1
18.6
0.7
2.2
215.6
246.5
2.0
19.0
0.7
(0.1)
268.2
3.4
0.3
2.0
0.1
5.8
6.8
0.3
3.0
0.1
10.1
8.3
0.3
2.0
0.1
10.6
6.6
0.3
2.0
0.1
9.0
Total Assets
121.8
170.8
226.3
277.2
Liabilities
Accounts payable
Accrued liabilities
Accrued marketing
Current portion of deferred rent
Current portion of note payable to related party
Current portion of subordinated notes payable
Current portion of capital lease obligations
Total Current Liabilities
66.6
7.5
0.2
74.3
74.3
8.0
0.2
82.6
100.2
13.1
(0.1)
113.1
122.2
17.9
(0.6)
139.6
Deferred rent, less current portion
Note payable to related party, less current portion
Capital lease obligations, less current portion
Redeemable convertible preferred stock
Total Long Term Liabilities
0.7
0.7
0.6
0.6
0.6
0.6
0.6
0.6
Total Liabilities
74.9
83.2
113.7
140.2
Shareholder Equity
Preferred stock
Common Stock
Additional Paid in Capital
Deferred compensation
Accumulated deficit
Treasury stock
Total Equity
0.0
115.8
(0.2)
6.7
(75.4)
46.9
87.6
112.6
136.9
Total Liabilities + Equity
121.8
170.8
226.3
277.2
Assets
Cash and cash equivalents
Restricted cash
Marketable securities
Accounts receivable
Inventories
Deferred income taxes
Prepaids and other current assets
Total Current Assets
Property and equipment, net
Intangible assets, net
Deferred income taxes, net
Other assets
Total Long Term Assets
Source: Company reports and JPMorgan estimates.
134
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 78: NILE Annual Cash Flow
$ in millions
2006
2007E
2008E
2009E
13.1
1.9
0.0
4.4
2.7
2.7
(0.2)
15.9
0.2
(2.9)
0.1
16.5
2.2
(0.2)
40.5
17.3
1.8
(0.0)
5.9
(1.1)
6.2
(1.6)
20.0
(0.6)
(1.8)
(2.8)
21.7
3.5
(0.1)
48.5
20.6
2.5
6.3
(1.0)
32.2
0.1
(0.3)
1.9
25.9
5.1
(0.4)
60.7
25.0
2.9
7.1
(1.0)
28.5
0.1
(0.4)
2.3
22.1
4.9
(0.5)
62.5
38.6
27.8%
43.5
12.6%
56.7
30.4%
54.5
-3.7%
(1.9)
0.0
0.0
23.0
21.1
(5.1)
0.0
0.1
19.8
14.8
(4.0)
(4.0)
(8.0)
(8.0)
-
-
-
-
(57.4)
2.3
0.2
-
(55.0)
(13.5)
5.4
1.6
0
0
0
0
(6.6)
-
-
Net Increase (decrease) in cash
6.6
56.8
56.7
54.5
Beginning Cash
Ending Cash
72.0
78.6
78.6
135.3
135.3
192.0
192.0
246.5
Operating Cash Flows
Net income
Depreciation and amortization
Loss on asset retirement
Stock-based compensation expense
Warrant based interest expense
Restructuring charges
Deferred income taxes
Tax benefit from exercise of stock options
Excess tax benefit from exercise of stock options
Changes in working capital
Receivables, net
Inventories
Prepaid expenses and other assets
Accounts payable
Accrued liabilities
Deferred rent
Cash From Operations
FCF
Investing Cash Flows
Purchases of property and equipment
Proceeds from sales of property and equipment
Transfers to restricted cash
Purchase/Sale of marketable securities
Cash From Investing
Financing Cash Flows
Proceeds from sale of common stock, net of issuance costs
Proceeds from sale of mandatorily redeemable convertible preferred stock, net of issuance
costs
Repurchase of restricted and common stock
Proceeds from stock option exercises
Excess tax benefit from exercise of stock options
Net repayments on line of credit
Payments on subordinated notes payable
Payments on capital lease obligations
Payments on note payable to related party
Payment on note payable
Proceeds from warrant and stock option exercises
Cash From Financing
Source: Company reports and JPMorgan estimates.
135
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
CNET Networks, Neutral ($8.90)
While we believe the CPM growth rate will accelerate in F’08 after a soft F’07, we
expect some of the challenges CNET faced in F’07 to persist in the coming year.
•
Core audience unlikely to grow. We continue to believe that much of the
audience for CNET’s core tech vertical is tech savvy and thus already
online. As such, the rising tide of continued growth in Internet penetration is
not likely to significantly raise the tech sites’ audience. comScore data
suggests US users for CNET’s core sites are growing at half the pace of
overall US Internet users. (See Figure on next page).
•
Non-tech verticals outpacing core CNET. Third-party metrics suggest
growth at sites such as GameSpot is significantly exceeding that of the core
tech vertical. However, we believe it will take time for CNET to drive
CPMs at non-tech sites to levels similar to those of core CNET, as the
company builds out ad sales forces familiar with those verticals.
•
Sale of WebShots removes a growth drag. CNET’s sale of WebShots to
American Greetings was a positive step, allowing the company to focus on
creating and nourishing successful brands. We expect the company to
continue to reevaluate its brands and sites going forward.
•
CPMs appear poised to rise. On a positive note, we think that, after an
influx of inventory pressured CPMs in F’07, ad pricing for graphical ads is
likely to start growing at a faster pace in F’08 than it has in the past year.
•
2008 Drivers. In our view, the following factors will drive the stock in
2008: (1) CPM pricing trends for graphical ads; (2) usage trends at CNET’s
core sites; (3) usage uptake at newer CNET verticals; (4) CNET’s ability to
monetize non-tech sites; and (5) CNET’s ability to monetize its non-US
traffic.
•
Maintaining Q4’07 and F’07 estimates. We continue to expect CNET to
post revenue, EBITDA and EPS of $122M, $36M and $1.29, respectively,
in 4Q, and $411M, $82M and $1.12, respectively, for the full year.
Table 79: CNET Estimates Snapshot
$ in millions, except per share data
CNET
4Q'07E
F'07E
F'09E
F'07E
Y/Y
F'08E
F'09E
JPM
Revenue
EBITDA
EPS
122.1
36.3
1.29
410.9
81.9
1.12
450.8
99.6
0.14
494.0
117.7
0.22
5.9%
86.1%
NM
9.7%
21.7%
NM
9.6%
18.1%
57.1%
Consensus
Revenue
EBITDA
EPS
122.5
33.3
1.29
410.8
70.1
1.12
449.4
91.5
0.14
486.0
96.8
0.21
5.9%
59.4%
NM
9.4%
30.5%
NM
8.2%
5.8%
56.6%
Source: Company reports, FactSet, JPMorgan estimates.
136
F'08E
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We expect F’08 to see a continuation of many of the trends that CNET encountered
in F’07:
User growth at core site is slowing
The core, tech-focused CNET brand attracts an audience that is tech-savvy, and as
such we continue to believe that this core audience has long been online – and
increased secular Internet use is unlikely to translate into rapid user growth for the
core site. ComScore data for the last two years supports this view:
Figure 82: Core CNET user growth below Internet usage growth
CAGR, 4Q'05 - 4Q'07
4%
4%
3%
2%
2%
1%
0%
CNET
US Internet
Source: comScore Networks, JPMorgan Estimates
Non-tech sites still in early stages
Aside from GameSpot, we believe CNET’s non-tech verticals are still in the early
stages of their growth. As such, while we think there is significant promise from
these sites, we do not expect significant monetization from them in the near term.
Slightly adjusting estimates
We think the sale of WebShots suggests CNET is willing to look critically at all of
the parts of its portfolio of sites. Further, we are encouraged by the company’s efforts
to build relationships with advertisers in non-tech areas and the investments CNET is
making outside the US. Additionally, we are more positive on broader CPM growth
in the graphical ad market than we were coming into F’07.
As such, we now expect F’08 revenue of $451M, up from $444M previously,
representing 12% Y/Y growth after adjusting for the sale of WebShots. At the same
time, we think higher investment in new products will lead to somewhat lower
profitability – we now estimate EBITDA of $100M, from $103M previously. We see
F’07 EPS of $0.14, compared to our previous $0.16 estimate.
Our Estimates and Outlook for 2009
We are introducing our F’09 estimates for CNET, as follows: we expect 11%
revenue growth in F’09, to $494M. We believe profitability will improve due to
increased scale and improved pricing, with operating margins rising to 23.8%, from
22.1% in F’08. As such, we are projecting EBITDA of $118M, up 18% Y/Y, and
EPS of $0.22.
137
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
By F’09, we think some of CNET’s non-tech verticals will likely be able to
contribute more meaningfully, although we think it is likely that there will be some
misses in addition to the hits.
Further, as online advertising matures in markets outside the US and UK, we think
F’09 could be the year when monetization at the company’s international sites
improves, although we think it is unlikely to reach parity with US and UK
monetization in the foreseeable future.
Valuation and Rating Analysis
On an EV/EBITDA basis, CNET trades at 13.7x our F’08 EBITDA estimate of
$99.6M, in line with a 12.1x for its peer group. Given the secular challenges, we
think multiple expansion is unlikely, and as such, we maintain our Neutral rating.
Risks to Our Rating
CNET is highly dependent on the performance of the online advertising industry.
During the recent quarter, the majority of CNET’s revenues came from its Marketing
Services business segment. The advertising industry is very susceptible to
overarching economic conditions, making a large portion of CNET’s revenues
vulnerable to general economic risk. Changes in the competitive landscape or new
regulations could also significantly impact CNET’s main revenue stream, presenting
a downside risk to our rating. On the contrary, should CNET grow at a faster rate
than the online industry or further improve its contribution margins, our outlook
could prove to be too conservative. Also, if the company further improves its
operating margins, the stock could outperform its peers.
138
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 80: CNET Annual Income Statement
$ in millions, except per share data
Marketing services
Licensing
Total Revenue
FY-06
337.3
50.3
387.7
363.2
47.6
410.9
405.3
45.5
450.8
FY-09E
450.4
43.7
494.0
Cost of Revenue
162.2
166.0
170.9
180.5
Gross Profit
Gross Margin
225.5
58.2%
244.9
59.6%
279.9
62.1%
313.5
63.5%
Sales and Marketing
General and Administrative
Unusual Inc./Expense
Depreciation
Amort.Intangibles
Asset Impairment
Stock Compensation
Total Expenses
Total Recurring Expenses
94.7
50.3
13.7
22.8
11.9
2.8
19.8
216.1
145.0
106.2
56.8
7.8
28.4
12.4
19.0
19.9
250.4
162.9
117.7
62.6
36.7
12.8
23.3
253.1
180.3
126.7
69.1
40.8
12.8
24.0
273.4
195.8
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
9.4
80.5
2.4%
20.8%
(5.6)
81.9
-1.4%
19.9%
26.8
99.6
6.0%
22.1%
40.1
117.7
8.1%
23.8%
EBITDA
80.5
81.9
99.6
117.7
Realized gain on sale of investments
Interest Income
Interest Expense
Other, Net
Total Other, Reported
Total Other, Pro Forma
0.6
4.9
(5.0)
(0.5)
(0.1)
(0.6)
2.2
3.3
(5.3)
2.4
2.7
0.5
2.0
(5.6)
(3.6)
(3.6)
2.0
(5.6)
(3.6)
(3.6)
9.3
(2.9)
23.2
36.5
1.5
15.7%
7.9
(175.8)
nm
172.9
1.5
6.4%
21.7
2.1
5.7%
34.4
Extraordinary Item
(0.0)
-
-
-
Reported Net Income
Reported EPS
7.8
0.05
172.9
1.12
21.7
0.14
34.4
0.22
152.3
153.3
154.7
155.9
87.0%
13.0%
24.4%
13.0%
88.4%
11.6%
25.8%
13.8%
89.9%
10.1%
26.1%
13.9%
91.2%
8.8%
25.7%
14.0%
15%
21%
14%
8%
-5%
6%
12%
13%
12%
-4%
10%
11%
10%
11%
-4%
10%
8%
10%
Income Before Taxes
Income Taxes
Tax Rate
Income After Taxes
Diluted Shares
% of Total Revenue
Marketing services
Licensing
Sales and Marketing
G&A
Q/Q change
Marketing services
Licensing
G&A
Y/Y Change
Marketing services
Licensing
Total Revenue
Sales and Marketing
G&A
FY-07E
FY-08E
Source: Company reports and JPMorgan estimates.
139
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 81: CNET Quarterly Income Statement
$ in millions, except per share data
Marketing services
Licensing
Total Revenue
Cost of Revenue
1Q'06
71.2
12.4
83.7
FY 2006
2Q'06
3Q'06
79.8
80.7
12.6
12.6
92.4
93.3
4Q'06
105.7
12.7
118.4
1Q'07
80.1
12.0
92.1
FY 2007E
2Q'07
3Q'07
85.5
87.6
11.7
11.9
97.2
99.5
4Q'07E
110.0
12.1
122.1
1Q'08E
87.3
11.4
98.7
FY 2008E
2Q'08E
3Q'08E
94.9
95.4
11.1
11.3
106.0
106.8
4Q'08E
127.6
11.7
139.3
39.5
38.6
40.1
44.0
41.7
40.5
40.9
42.8
42.3
42.0
41.4
45.1
44.2
52.8%
53.8
58.2%
53.2
57.0%
74.3
62.8%
50.4
54.7%
56.7
58.3%
58.6
58.9%
79.2
64.9%
56.4
57.1%
64.0
60.4%
65.4
61.2%
94.2
67.6%
22.1
12.1
4.8
2.7
4.8
46.5
34.2
23.8
11.1
1.4
5.3
2.7
4.6
49.0
35.0
22.3
12.4
5.8
5.9
3.2
1.4
5.0
56.0
34.7
26.5
14.7
6.5
6.9
3.2
1.4
5.4
64.6
41.2
25.1
13.5
4.4
7.5
3.2
5.2
58.9
38.6
26.8
13.7
2.9
7.0
3.2
4.1
57.6
40.5
26.8
14.1
0.4
6.8
3.3
19.0
4.7
75.1
40.9
27.5
15.5
0.1
7.2
2.7
6.0
58.8
43.0
27.8
14.8
8.5
3.2
5.7
60.0
42.6
29.9
14.9
8.9
3.2
5.4
62.3
44.8
28.6
15.7
9.4
3.2
6.1
63.0
44.3
31.3
17.1
9.9
3.2
6.1
67.7
48.5
(2.3)
10.0
-3%
11.9%
4.8
18.8
5.2%
20.4%
(2.8)
18.5
-3.0%
19.8%
9.7
33.1
8.2%
28.0%
(8.5)
11.8
-9%
12.8%
(1.0)
16.2
-1.0%
16.6%
(16.5)
17.7
-16.5%
17.8%
20.4
36.3
16.7%
29.7%
(3.7)
13.7
-3.7%
13.9%
1.7
19.2
1.6%
18.1%
2.3
21.0
2.2%
19.7%
26.5
45.7
19.0%
32.8%
EBITDA
10.0
18.8
18.5
33.1
11.8
16.2
17.7
36.3
13.7
19.2
21.0
45.7
Realized gain on sale of investments
Interest Income
Interest Expense
Other, Net
Total Other, Reported
Total Other, Pro Forma
0.5
1.2
(0.7)
0.1
1.1
0.6
1.3
(0.7)
(0.1)
0.5
0.5
0.1
1.6
(0.7)
(0.0)
0.9
0.9
0.9
(3.0)
(0.5)
(2.7)
(2.7)
0.6
(1.3)
0.3
(0.4)
(0.4)
1.6
0.9
(1.3)
(0.2)
1.0
(0.6)
0.6
1.0
(1.2)
0.9
1.2
0.7
0.7
(1.4)
1.5
0.8
0.8
0.5
(1.4)
(0.9)
(0.9)
0.5
(1.4)
(0.9)
(0.9)
0.5
(1.4)
(0.9)
(0.9)
0.5
(1.4)
(0.9)
(0.9)
Income Before Taxes
(1.2)
5.4
(1.9)
7.1
(8.9)
0.0
(15.2)
21.2
(4.6)
0.8
1.4
25.6
Income Taxes
Tax Rate
Income After Taxes
0.1
-6%
(1.3)
0.2
4%
5.2
0.4
-22%
(2.3)
0.8
11%
6.3
0.2
nm
(9.1)
0.1
nm
(0.1)
1.4
nm
(16.6)
(177.5)
nm
198.7
0.1
5%
(4.7)
0.0
5%
0.7
0.1
5%
1.4
1.3
5%
24.3
Extraordinary Item
(0.0)
-
-
-
-
-
-
-
-
-
-
-
(1.3)
$ (0.01)
5.2
$ 0.03
(2.3)
$ (0.02)
6.3
$ 0.04
(9.1)
$ (0.06)
(0.1)
$ (0.00)
(16.6)
$ (0.11)
198.7
$ 1.29
(4.7)
$ (0.03)
0.7
$ 0.00
1.4
$ 0.01
24.3
$ 0.16
Gross Profit
Gross Margin
Sales and Marketing
General and Administrative
Unusual Inc./Expense
Depreciation
Amort.Intangibles
Asset Impairment
Stock Compensation
Total Expenses
Total Recurring Expenses
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
Reported Net Income
Reported EPS
140
Imran Khan
(1-212) 622-6693
[email protected]
Diluted Shares
% of Total Revenue
Marketing services
Licensing
Sales and Marketing
G&A
Q/Q change
Marketing services
Licensing
G&A
Y/Y Change
Marketing services
Licensing
Total Revenue
Sales and Marketing
G&A
North America Equity Research
02 January 2008
148.7
152.8
149.8
152.6
150.4
151.3
151.7
154.0
154.3
154.6
154.9
155.2
85.2%
14.8%
26.4%
14.5%
86.4%
13.6%
25.8%
12.1%
86.4%
13.6%
23.9%
13.3%
89.3%
10.7%
22.4%
12.4%
87.0%
13.0%
27.2%
14.7%
88.0%
12.0%
27.6%
14.1%
88.0%
12.0%
26.9%
14.1%
90.1%
9.9%
22.5%
12.7%
88.5%
11.5%
28.2%
15.0%
89.5%
10.5%
28.2%
14.1%
89.4%
10.6%
26.8%
14.7%
91.6%
8.4%
22.5%
12.3%
#DIV/0!
#DIV/0!
-1.7%
12.0%
1.3%
-8.1%
1.1%
0.5%
11.0%
31.0%
0.5%
18.7%
-24.2%
-5.7%
-7.9%
6.7%
-2.6%
1.1%
2.4%
2.4%
3.0%
25.6%
1.0%
10.1%
-20.6%
-5.7%
-4.5%
8.7%
-2.6%
1.0%
0.5%
2.4%
5.0%
33.7%
3.2%
9.2%
19%
7%
17%
19%
12%
14%
15%
14%
21%
-8%
13%
14%
13%
14%
1%
n/a
n/a
14%
26%
19%
12%
-4%
10%
14%
11%
7%
-7%
5%
13%
23%
9%
-6%
7%
20%
14%
4%
-5%
3%
4%
6%
9%
-5%
7%
11%
9%
11%
-5%
9%
11%
9%
9%
-5%
7%
7%
11%
16%
-3%
14%
14%
11%
Source: Company reports and JPMorgan estimates.
141
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 82: CNET Annual Balance Sheet
$ in millions
FY-06
FY-07E
FY-08E
FY-09E
Assets
Cash/Equivalents
Marketable Debt Sec.
Marketable Equity
Acct. Receivable
Other Current
Dfrd. Income Tax
Total Current Assets
31.3
30.4
90.4
10.4
162.6
125.4
16.0
97.7
12.2
251.2
178.7
16.0
111.4
13.9
320.0
241.1
16.0
121.3
15.2
393.5
Restricted Cash
Debt Sec. Investment
Equity Invest.
Prop. & Equip., Net
Other Assets
Dfrd. Income Taxes
Intangibles, Net
Goodwill
Total Assets
2.2
13.9
72.6
15.6
34.8
133.2
434.9
1.6
0.5
71.8
14.2
37.6
101.5
478.3
1.6
0.5
71.8
14.2
37.6
101.5
547.1
1.6
0.5
71.8
14.2
37.6
101.5
620.7
Liabilities
Accounts Payable
Line of Credit
Accrued Liabilities
Cur. Port. LT Debt
Tax Related
Dfrd. Tax Liabs.
Bank Overdraft
Total Current Liabs
10.1
60.0
80.4
13.8
164.2
11.0
60.0
79.3
3.3
153.7
12.5
60.0
90.5
3.3
166.4
13.6
60.0
98.5
3.3
175.5
4.5
4.5
2.8
2.8
2.8
2.8
2.8
2.8
0.7
169.4
4.1
160.6
4.1
173.4
4.1
182.5
0.0
2,857.2
(11.4)
(2,550.1)
(30.5)
265.3
317.7
0.0
0.0
0.0
0.0
0.0
0.0
373.8
0.0
0.0
0.0
0.0
0.0
0.0
438.2
434.9
478.3
547.1
620.7
LTD
Total Long Term Debt
Other Liabilities
Total Liabilities
Shareholder Equity
Common Stock
Paid in Capital
Other Equity
Conv. Pref. Stock & Deferred Stock Comp
Accumulated Deficit
Treasury Stock
Total Equity
Total Liabilities + Equity
Source: Company reports and JPMorgan estimates.
142
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 83: CNET Annual Cash Flow Statement
$ in millions
FY-06
FY-07E
FY-08E
FY-09E
Operating Cash Flows
Net Income
Depreciation & Amort
Stock compensation expense
Deferred Taxes
Fair Value Remeasurement
Non-Cash Items
Noncash Interest
Goodwill Impairment
Loss-Sale of Assets
Debt Retirement
Extraordinary Loss
Doubtful Accounts
Gain on Sale of Business
Investment Sales & Equity Loss
Working Capital
Cash From Operations
7.8
34.7
19.8
-
172.9
40.8
19.9
(177.5)
21.7
49.5
23.3
-
34.4
53.6
24.0
-
(0.6)
2.8
0.3
2.5
(0.3)
(0.6)
(4.6)
61.8
(0.1)
(0.1)
19.0
1.6
(2.2)
0.1
73.7
94.5
112.0
FCF
29.0
42.7
48.5
57.7
Investing Cash Flows
Purch.-Mktbl. Secs.
Purch.- Mktbl. Debt
Proc. Mktbl. Debt
Proc. Mktbl. Equity
Release of restrictions on cash
Other Investing
Capital Expenditures
Cash Acq. & Asset Sales, Net
Cash From Investing
(45.5)
57.6
0.1
3.1
(32.8)
(14.5)
(32.1)
(9.4)
38.7
1.6
0.6
2.5
(31.0)
5.4
8.5
(46.0)
(46.0)
(54.3)
(54.3)
Financing Cash Flows
Pmt from Sharehold notes
Net borrowing on credit facility
Pmt from Employee stk plan
Purch./Sale of Stock
Payments-Cap. Leases
Debt, Net
Common/Options/ESOP
Cash From Financing
(62.9)
7.3
(55.7)
(0.0)
(0.0)
11.7
11.6
4.7
4.7
4.7
4.7
Net Increase (decrease) in cash
(25.9)
93.8
53.3
62.5
1.4
55.9
31.3
0.2
31.3
125.4
125.4
178.7
178.7
186.5
Foreign Exch Effects
Beginning Cash
Ending Cash
Source: Company reports and JPMorgan estimates.
143
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
eBay, Overweight ($34.49)
After Y/Y listings declines in the first nine months of F’07, 4Q’07 saw reaccelerated
listings growth, and the company has made several incremental structure and pricing
changes intended to strengthen the core site. We maintain our optimistic outlook as
we see continued RPL and listings growth in F’08 and F’09, and believe the PayPal
franchise’s increasing off-eBay penetration remains a growth driver for the company.
•
PayPal is a catalyst for growth. PayPal is no longer just a lubricant for the
eBay marketplace; in the first three quarters of ’07, 41.5% of PayPal TPV
was off-eBay, a rise of over 650 bps Y/Y. We think this trend is likely to
continue, and thus we are projecting PayPal revenue to grow 25% in F’08
and 23% in F’09, even as eBay GMV rises 10% in both years.
•
Will eBay experiment with site structure? The company has made public
statements suggesting alternative fee schedules for the core site may be
considered, possibly shifting toward lower listing fees and higher finalvalue fees. We believe the ’06 shift in Stores listings has ensured that eBay
will make changes very tentatively and after experimentation. Additionally,
we expect revenue loss from the introduction of lower listing fees will be
offset by higher final value fees and faster listings growth. As such, we
expect neutral near-term impact from site structure changes.
•
Strong growth from StubHub!, ad revenues and classifieds. We believe
eBay’s businesses outside the core marketplace are poised for continued
strength in F’08. We think the international expansion of StubHub! presents
a significant growth opportunity, and we believe eBay is likely to start
reaping increased rewards as its advertising deal with Google matures.
•
2008 Drivers. In our view, the following factors will drive the stock in
2008: (1) RPL improvements; (2) impact of promotions and price changes
on marketplace ecosystem; (3) growth in non-GMV businesses; (4)
improved int’l PayPal penetration; (5) growing PayPal presence off-eBay.
•
Maintaining 4Q’07 and F’07 estimates. Our listings tracking and
conversations with sellers give us confidence in our 4Q’07 revenue,
EBITDA and pro forma EPS estimates of $2.19B, $726M and $0.40. For
the full year, we expect $7.68B, $2.55B and $1.48, respectively.
Table 84: eBay Consensus Snapshot
$ in millions, except per share data
EBAY
F'07E
F'08E
F'09E
JPM
Revenue
EBITDA
EPS
2,193
811
0.40
7,685
2,863
1.48
9,007
3,337
1.70
10,506
3,754
1.98
28.7%
1.6%
41.2%
17.2%
17.7%
14.6%
16.6%
13.9%
16.7%
Consensus
Revenue
EBITDA
EPS
2,136
823
0.40
7,632
2,915
1.49
9,031
3,392
1.66
10,603
3,848
1.94
27.8%
16.4%
41.8%
18.3%
16.4%
11.6%
17.4%
13.5%
16.9%
Source: Company reports, FactSet, JPMorgan estimates.
144
F'07E
Y/Y
F'08E
4Q'07E
F'09E
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Key Financial Metrics and Forecasts
The following tables summarize our revenue forecast by business segment as well as
our estimate for Y/Y growth in key auction metrics.
Table 85: eBay Revenue Forecast by Segment
$ in millions
2006A
52,473
18%
2007E
59,384
13%
2008E
65,362
10%
2009E
71,573
10%
1,402
4,203
5,605
172
193
5,970
1,817
5,206
7,023
294
368
7,685
2,278
5,795
8,073
424
510
9,007
2,805
6,439
9,244
572
690
10,506
2006A
2,366
2007E
2,374
0.4%
2008E
2,499
5.3%
2009E
2,670
6.8%
GMV/Auction
% change Y/Y
$ 22.17
$ 25.06
13.1%
$ 26.18
4.4%
$ 26.83
2.5%
eBay Online Revenue / Auction
% change Y/Y
$ 1.78
$ 2.19
23.5%
$ 2.32
5.7%
$ 2.41
4.0%
Gross Merchandise Volume (GMV)
% change Y/Y
Payment revenue
eBay online revenue
Total Transaction revenue
3rd party advertising revenue
Skype
Total Online Revenue
Source: Company reports and JPMorgan estimates
Table 86: eBay Auction Metrics forecasts
Auctions in millions
Auctions (M)
% change Y/Y
Source: Company reports and JPMorgan estimates
Our Estimates and Outlook for 2008
With the marketplace changes resulting from the August 2006 price rebalancing fully
anniversaried, we think eBay is poised to follow roughly flat F’07 Y/Y listings
growth with 5% Y/Y listings growth in F’08. At the same time, we think the
company can improve revenue per listing 6% Y/Y in F’08. We think PayPal
revenues can grow 25% Y/Y (after a projected 30% Y/Y growth rate in F’07).
As such, we are now modeling F’08 revenue of $9.0B, up ~$10M from our previous
estimate. We are projecting ~36 bps operating margin erosion, to 31.9%, and
EBITDA of $3.0B, up from $2.97B. We are raising our pro forma F’08 EPS estimate
for eBay to $1.70, from $1.68 previously.
Our Estimates and Outlook for 2009
For F’09, we expect eBay’s marketplace improvements to help generate a healthier
buyer-seller ecosystem, driving a slight acceleration in listings growth, to 7% Y/Y.
At the same time, we think RPL growth is likely to slow somewhat, and we are
projecting RPL up 4% Y/Y in F’09. In part, we expect slower RPL growth as the rate
of increase moderates at non-GMV businesses such as StubHub! as they reach
greater size. Likewise, we expect PayPal revenue growth to slow slightly in F’09, to
23%.
Our forecast calls for F’09 revenue of $10.5B, EBITDA of $3.41B and pro forma
EPS of $1.98. We expect operating margin erosion of ~60 bps, driven by gross
145
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
margin pressure from a revenue mix that tilts more heavily toward lower-grossmargin PayPal revenue.
Valuation and Rating Analysis
On an EV/EBITDA basis, eBay trades 12.7x our F’08 estimate, compared to its peers
at 18.0x F’08 estimates. We think such a discount is unwarranted.. We thus reiterate
our Overweight rating.
Risks to Our Rating
Risks associated with our Overweight rating include: barriers to international
expansion, competition from sponsored search vendors, the company’s dependence
on eBay Motors, competition from hardline retailers, risks associated with patent
litigation, and valuation risks.
International expansion is a concrete part of eBay’s growth strategy. As the company
continues to grow outside the U.S., it may face regulatory challenges and/or markets
that make its business less profitable than it is in the U.S. or other countries where it
is already established. Thus far, we believe eBay’s international expansion has been
carried out in a strategic and timely manner.
eBay also faces risks from hardline retailers. Although the bulk of eBay’s revenues
come from the beginning and end of the retail life cycle, with each passing quarter,
the percentage of revenue it earns from the in-season retail and fixed price sales
continues to increase. This puts the company in competition with traditional retailers
and other e-tailers, including Amazon.com, Wal-Mart, BestBuy, and Home Depot.
Failure to meet these challenges could lead to relative stock price underperformance.
146
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 87: EBAY Annual Income Statement
$ in millions, except per share data
FY
2006A
$52,473.0
18%
FY
2007E
$59,383.5
13%
FY
2008E
$65,361.8
10%
FY
2009E
$71,573.3
10%
Payment revenue
eBay online revenue
Total transactions
3rd party advertising revenue
Skype
End-to-end Services
Total Online Revenue
Offline revenue
Total revenue
1,401.8
4,203.3
5,605.2
171.8
192.8
5,970
5,969.7
1,817.1
5,206.0
7,023.0
293.7
368.0
7,684.7
7,684.7
$2,278.4
$5,794.5
$8,073.0
$424.3
$510.0
$9,007.3
9,007.3
$2,805.0
$6,438.6
$9,243.7
$572.1
$690.0
$10,505.8
10,505.8
Cost of revenue
COGS pro forma adjustment
1243.1
-11.3
1,770.0
(27.5)
2,164.9
-
2,637.4
-
Gross Profit
Gross Profit (pro forma)
Pro Forma Gross Margin
4726.7
4759.6
79.7%
5,914.6
5,942.2
77.3%
$6,842.4
$6,842.4
76.0%
$7,868.4
$7,868.4
74.9%
Sales and Marketing
Product Development
General and Admin.
Amort., Payroll Taxes, merger other
Total Operating Expenses
Pro forma op ex adjustments:
Sales & marketing
Product development
G&A
Payroll exp on empl stock options
Amort of acq'd assets
Total
Pro forma operating expenses
1654.7
494.7
941.2
213.1
3303.7
1,958.9
641.2
1,162.9
1,598.7
5,361.7
2,232.0
807.7
1,217.3
228.0
4,485.1
2,550.9
921.1
1,394.2
228.0
5,094.2
(96.55)
(81.49)
(106.39)
(5.32)
(214.9)
(504.68)
2799.0
(64.49)
(56.77)
(83.39)
(5.36)
(1,557.1)
(1,895)
3,466.6
(512)
3,973.1
(512)
4,582.2
Operating Profit (reported)
Operating Margin (reported)
1423.0
23.8%
552.9
7.2%
2,357.3
26.2%
2,774.2
26.4%
Operating Profit (pro forma)
Operating Margin (pro forma)
1960.6
32.8%
2475.5
32.2%
2869.3
31.9%
3286.2
31.3%
Interest and other income, net
Interest Expense
Net Interest Income
Pro forma adjustment
Pro forma interest
Impairment of Equity Investments
130.0
(5.9)
124.1
124.1
-
137.4
(13.0)
124.3
124.3
-
165.0
(14.0)
151.0
151.0
-
195.0
(14.0)
181.0
181.0
-
2,284.9
23%
1,547.1
2,084.7
421.4
2,862.9
25%
677.3
2,599.9
405.5
116.6
558.6
3,337.3
27%
2,508.3
3,020.3
591.5
724.9
3,754.2
12%
2,955.2
3,467.2
679.7
832.1
Gross Merchandise Volume (GMV)
% Change Y-Y
% Change Q-Q
EBITDA
Y/Y Growth
IBT(reported)
IBT(pro forma)
Income Taxes
Pro forma adjustment
Pro forma tax
Minority Interest
Pro forma entry
Pro forma minority interest
Charitable contribution
Other non-cash charges
591.5
(0.0)
-
-
-
147
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
FY
2006A
1,125.6
1,493.3
FY
2007E
271.8
2,041.3
FY
2008E
1,916.8
2,295.4
FY
2009E
2,275.5
2,635.0
1,125.6
1,493.3
0.79
1.05
0.79
22%
271.8
2,041.3
0.19
1.48
0.19
41%
1,916.8
2,295.4
1.42
1.70
1.42
15%
2,275.5
2,635.0
1.71
1.98
1.71
17%
1,425.5
1,425.5
1,373.0
1,377.6
1,352.0
1,352.0
1,330.0
1,330.0
23.5%
70.4%
2.9%
3.2%
100.0%
0.0%
23.6%
67.7%
3.8%
4.8%
100.0%
0.0%
25.3%
64.3%
4.7%
5.7%
100.0%
0.0%
26.7%
61.3%
5.4%
6.6%
100.0%
0.0%
Cost of goods sold
Sales & marketing
Product development
G&A
Total operating expenses
20.8%
27.7%
8.3%
15.8%
55.3%
23.0%
25.5%
8.3%
15.1%
69.8%
24.0%
24.8%
9.0%
13.5%
49.8%
25.1%
24.3%
8.8%
13.3%
48.5%
Operating income (reported)
Operating income (pro forma)
Net income (reported)
Net income (pro forma)
Tax Rate
Pro forma tax rate
Year-Over-Year Growth
Payment revenue
eBay online revenue
Third Party Advertising revenue
End-to-end services revenue
Communications Revenue
Total online revenue
Offline Revenue
Sales & marketing
Product development
G&A
Total operating expenses
Operating income (pro forma)
23.8%
32.8%
18.9%
25.0%
27.2%
28.4%
7.2%
32.2%
3.5%
26.6%
59.9%
21.5%
26.2%
31.9%
21.3%
25.5%
23.6%
24.0%
26.4%
31.3%
21.7%
25.1%
23.0%
24.0%
39.9%
23.5%
39.3%
NM
31.1%
29.6%
23.9%
70.9%
NM
90.9%
28.7%
25.4%
11.3%
44.5%
NM
38.6%
17.2%
23.1%
11.1%
34.8%
NM
35.3%
16.6%
34.4%
50.7%
59.1%
18.4%
29.6%
23.6%
13.9%
26.0%
4.7%
14.3%
14.0%
14.5%
21.4%
26.3%
15.9%
14.5%
Net Income (reported)
Net Income (pro forma)
FASB Adjustment net of Taxes
Reported Net Income Adj. for FASB123
Pro Forma NI Adj. for FASB 123
EPS (reported)
EPS (pro forma)
Reported EPS Adj. for FASB123
EPS (pro forma) y/y
GAAP Diluted Share count
Pro Forma Diluted Outstanding Shares
2
As a % of Revenue
Payment revenue
eBay online revenue
Third Party Advertising revenue
Skype Revenue
Total online revenue
Offline Revenue
Source: Company reports and JPMorgan estimates.
148
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 88: EBAY Quarterly Income Statement
$ in millions, except per share data
Gross Merchandise Volume (GMV)
% Change Y-Y
% Change Q-Q
Payment revenue
eBay online revenue
Total transactions
3rd party advertising revenue
Skype
End-to-end Services
Total Online Revenue
Offline revenue
Total revenue
Q1-06
$12,504.0
17.9%
4.1%
FY 2006
Q2-06
Q3-06
$12,896.0
$12,639.0
18.5%
17.0%
3%
-2%
Q4-06
$14,434.0
20.2%
14%
Q1-07
$14,281.0
14.2%
-1%
FY 2007E
Q2-07
Q3-07
$14,464.0
$14,395.0
12.2%
13.9%
1%
0%
Q4-07E
$16,243.5
12.5%
13%
Q1-08E
$15,754.4
10.3%
-3%
FY 2008E
Q2-08E
Q3-08E
$15,913.1
$15,649.5
10.0%
8.7%
1%
-2%
Q4-08E
$18,044.8
11.1%
15%
328.2
990.5
1,318.7
36.6
35.2
1,390.4
$1,390.4
330.7
997.1
1,327.8
38.8
44.2
1,410.8
$1,410.8
340.0
1,017.3
1,357.3
41.3
50.0
1,448.6
1,448.6
403.0
1,198.4
1,601.4
55.1
63.4
1,719.9
$1,719.9
419.0
1,211.5
1,630.5
60.5
77.1
1,768.1
$1,768.1
432.3
1,236.8
1,669.1
76.2
89.1
1,834.43
$1,834.4
448.0
1,267.5
1,715.4
77.0
96.8
1,889.2
$1,889.2
517.8
1,490.1
2,007.9
80.0
105.0
2,192.9
$2,192.9
541.7
1,402.5
1,944.1
90.1
115.0
2,149.2
$2,149.2
538.3
1,387.9
1,926.3
108.9
125.0
2,160.2
$2,160.2
553.9
1,360.6
1,914.5
111.7
130.0
2,156.2
$2,156.2
644.5
1,643.6
2,288.1
113.6
140.0
2,541.7
$2,541.7
278.6
(9.5)
292.5
(7.6)
315.7
(8.0)
356.3
(7.9)
393.7
(8.8)
416.8
(9.6)
446.5
(9.1)
513.0
512.3
517.4
525.9
609.4
1,111.9
1,121.3
80.6%
1118.3
1125.9
79.8%
1132.9
1140.9
78.8%
1,363.6
1,371.5
79.7%
1,374.4
1,383.2
78.2%
1,417.6
1,427.2
77.8%
1,442.7
1,451.8
76.8%
1,679.9
1,679.9
76.6%
1,636.9
1,636.9
76.2%
1,642.8
1,642.8
76.0%
1,630.3
1,630.3
75.6%
1,932.4
1,932.4
76.0%
400.6
119.1
215.4
54.25
789.2
398.0
124.0
222.9
62.00
806.9
394.8
120.4
227.2
51.47
793.9
461.3
131.2
275.7
45.40
913.7
443.3
137.6
278.4
47.35
906.6
477.8
147.9
283.5
51.55
960.7
485.2
164.9
287.4
1,442.8
2380.4
552.6
190.8
313.6
57.0
1114.0
533.0
191.3
298.7
57.0
1080.0
555.2
196.6
295.9
57.0
1104.7
554.1
196.2
284.6
57.0
1092.0
589.7
223.7
338.0
57.0
1208.4
(24.72)
(20.70)
(28.92)
(2.32)
(51.92)
(128.59)
660.6
(27.06)
(22.99)
(27.72)
(1.61)
(62.00)
(141.38)
665.5
(23.15)
(19.01)
(23.36)
(0.47)
(51.47)
(117.46)
676.4
(21.61)
(18.79)
(26.39)
(0.92)
(49.54)
(117.25)
796.5
(19.20)
(16.00)
(28.00)
(1.78)
(51.89)
(116.87)
789.7
(23.1)
(19.4)
(27.5)
(1.3)
(56.9)
(128.20)
832.5
(22.19)
(21.37)
(27.89)
(2.28)
(1,448.3)
(1,522.0)
858.4
-
-
-
-
-
(128.00)
986.0
(128.00)
952.0
(128.00)
976.7
(128.00)
964.0
(128.00)
1080.4
Operating Profit (reported)
Operating Margin (reported)
322.6
23.2%
311.4
22.1%
339.0
23.4%
449.9
26.2%
467.8
26.5%
456.9
24.9%
-937.7
-49.6%
565.9
25.8%
556.9
25.9%
538.1
24.9%
538.4
25.0%
724.0
28.5%
Operating Profit (pro forma)
Operating Margin (pro forma)
460.7
33.1%
460.4
32.6%
464.493
32.1%
575.0
33.4%
593.5
33.6%
594.7
32.4%
593.4
31.4%
693.9
31.6%
684.9
31.9%
666.1
30.8%
666.4
30.9%
852.0
33.5%
25.8
(0.7)
25.6
(0.9)
41.2
(0.6)
37.4
(3.7)
30.0
(4.5)
34.0
(2.7)
38.4
(2.7)
35.0
(3.0)
40.0
(3.5)
40.0
(3.5)
40.0
(3.5)
45.0
(3.5)
Cost of revenue
COGS pro forma adjustment
Gross Profit
Gross Profit (pro forma)
Pro Forma Gross Margin
Sales and Marketing
Product Development
General and Admin.
Amort., Payroll Taxes, merger other
Total Operating Expenses
Pro forma op ex adjustments:
Sales & marketing
Product development
G&A
Payroll exp on empl stock options
Amort of acq'd assets
Total
Pro forma operating expenses
Interest and other income, net
Interest Expense
149
Imran Khan
(1-212) 622-6693
[email protected]
Net Interest Income
Pro forma adjustment
Pro forma interest
Impairment of Equity Investments
North America Equity Research
02 January 2008
25.0
25.0
-
24.7
24.7
-
40.7
40.7
-
33.7
33.7
-
25.5
25.5
-
31.2
31.2
-
35.6
35.6
-
32.0
32.0
-
36.5
36.5
-
36.5
36.5
-
36.5
36.5
-
41.5
41.5
-
529.7
26%
$347.6
$485.7
99.4
43.4
142.8
539.2
16%
$336.1
$485.1
86.1
48.3
134.4
547.8
21%
$379.7
$505.2
98.8
38.9
137.8
668.2
30%
$483.6
$608.7
137.1
41.0
176.5
683.2
29%
$493.3
$619.0
116.1
42.3
158.4
683.2
27%
$488.1
$625.9
112.3
42.5
154.8
685.6
25%
($902.1)
$629.1
33.6
31.7
65.3
810.9
21%
$597.9
$725.9
143.5
801.9
17%
$593.4
$721.4
142.4
783.1
15%
$574.6
$702.6
137.9
783.4
14%
$574.9
$702.9
135.1
969.0
19%
$765.5
$893.5
176.1
180.0
173.1
168.6
168.7
214.4
Charitable contribution
Other non-cash charges
(0.00)
-
(0.00)
-
(0.00)
-
(0.00)
-
-
-
-
-
-
-
-
-
Net Income (reported)
Net Income (pro forma)
FASB Adjustment net of Taxes
Reported Net Income Adj. for FASB123
Pro Forma NI Adj. for FASB 123
EPS (reported)
EPS (pro forma)
Reported EPS Adj. for FASB123
EPS (pro forma) y/y
248.3
342.9
248.3
342.9
0.17
0.24
0.17
20%
250.0
350.7
280.9
367.4
346.5
432.2
377.2
460.5
375.8
471.1
(935.6)
563.8
454.4
545.9
451.0
548.3
436.7
534.0
439.8
534.2
589.4
679.0
250.0
350.7
0.17
0.24
0.17
10%
280.9
367.4
0.20
0.26
0.20
28%
346.5
432.2
0.25
0.31
0.25
29%
377.2
460.5
0.27
0.33
0.27
39%
375.8
471.1
0.27
0.34
0.27
40%
(935.6)
563.8
(0.69)
0.41
(0.69)
59%
454.4
545.9
0.33
0.40
0.33
29%
451.0
548.3
0.33
0.40
0.33
20%
436.7
534.0
0.32
0.40
0.32
16%
439.8
534.2
0.33
0.40
0.33
-3%
589.4
679.0
0.44
0.51
0.44
27%
GAAP Diluted Share count
Pro Forma Diluted Outstanding Shares
2
As a % of Revenue
Payment revenue
eBay online revenue
Third Party Advertising revenue
Skype Revenue
Total online revenue
Offline Revenue
1,437.6
1,437.6
1,435.8
1,435.8
1,426.1
1,426.1
1,402.7
1,402.7
1,384.3
1,384.3
1,379.7
1,379.7
1,354.8
1,373.3
1,373.3
1,373.3
1,370.0
1,370.0
1,350.0
1,350.0
1,348.0
1,348.0
1,340.0
1,340.0
23.6%
71.2%
2.6%
2.5%
100.0%
0.0%
23.4%
70.7%
2.8%
3.1%
100.0%
0.0%
23.5%
70.2%
2.9%
3.5%
100.0%
0.0%
23.4%
69.7%
3.2%
3.7%
100.0%
0.0%
23.7%
68.5%
3.4%
4.4%
100.0%
0.0%
23.6%
67.4%
4.2%
4.9%
100.0%
0.0%
23.7%
67.1%
4.1%
5.1%
100.0%
0.0%
23.6%
68.0%
3.6%
4.8%
100.0%
0.0%
25.2%
65.3%
4.2%
5.4%
100.0%
0.0%
24.9%
64.2%
5.0%
5.8%
100.0%
0.0%
25.7%
63.1%
5.2%
6.0%
100.0%
0.0%
25.4%
64.7%
4.5%
5.5%
100.0%
0.0%
Cost of goods sold
Sales & marketing
Product development
G&A
Total operating expenses
20.0%
28.8%
8.6%
15.5%
56.8%
20.7%
28.2%
8.8%
15.8%
57.2%
21.8%
27.3%
8.3%
15.7%
54.8%
20.7%
26.8%
7.6%
16.0%
53.1%
22.3%
25.1%
7.8%
15.7%
51.3%
22.7%
26.0%
8.1%
15.5%
52.4%
23.6%
25.7%
8.7%
15.2%
126.0%
23.4%
25.2%
8.7%
14.3%
50.8%
23.8%
24.8%
8.9%
13.9%
50.3%
24.0%
25.7%
9.1%
13.7%
51.1%
24.4%
25.7%
9.1%
13.2%
50.6%
24.0%
23.2%
8.8%
13.3%
47.5%
Operating income (reported)
23.2%
22.1%
23.4%
26.2%
26.5%
24.9%
-49.6%
25.8%
25.9%
24.9%
25.0%
28.5%
EBITDA
Y/Y Growth
IBT(reported)
IBT(pro forma)
Income Taxes
Pro forma adjustment
Pro forma tax
Minority Interest
Pro forma entry
Pro forma minority interest
150
Imran Khan
(1-212) 622-6693
[email protected]
Operating income (pro forma)
Net income (reported)
Net income (pro forma)
Tax Rate
Pro forma tax rate
Year-Over-Year Growth
Payment revenue
eBay online revenue
Third Party Advertising revenue
End-to-end services revenue
Communications Revenue
Total online revenue
Offline Revenue
Sales & marketing
Product development
G&A
Total operating expenses
Operating income (pro forma)
North America Equity Research
02 January 2008
33.1%
17.9%
24.7%
28.6%
29.4%
32.6%
17.7%
24.9%
25.6%
27.7%
32.1%
19.4%
25.4%
26.0%
27.3%
33.4%
20.1%
25.1%
28.4%
29.0%
33.6%
21.3%
26.0%
23.5%
25.6%
32.4%
20.5%
25.7%
23.0%
24.7%
31.4%
-49.5%
29.8%
-3.7%
10.4%
31.6%
20.7%
24.9%
24.0%
24.8%
31.9%
21.0%
25.5%
24.0%
24.0%
30.8%
20.2%
24.7%
24.0%
24.0%
30.9%
20.4%
24.8%
23.5%
24.0%
33.5%
23.2%
26.7%
23.0%
24.0%
44.5%
27.7%
27.5%
39.4%
21.6%
34.0%
41.7%
21.6%
43.6%
35.4%
23.6%
49.1%
27.7%
22.3%
65.3%
30.7%
24.0%
96.2%
31.7%
24.6%
86.5%
28.5%
24.3%
45.2%
29.3%
15.8%
49.0%
24.5%
12.2%
43.0%
23.7%
7.3%
45.0%
24.5%
10.3%
42.0%
34.8%
NM
47.6%
61.4%
57.9%
NM
25.4%
29.9%
NM
38.6%
73.1%
72.4%
NM
13.3%
31.0%
NM
34.4%
52.6%
57.5%
NM
18.0%
29.4%
NM
21.9%
26.3%
51.7%
NM
28.3%
27.2%
NM
10.7%
15.6%
29.3%
NM
28.8%
30.0%
NM
20.0%
19.3%
27.2%
NM
29.2%
30.4%
NM
22.9%
36.9%
26.5%
NM
27.8%
27.5%
NM
19.8%
45.4%
13.7%
NM
20.7%
21.6%
NM
20.2%
39.0%
7.3%
NM
15.4%
17.8%
NM
16.2%
32.9%
4.4%
NM
12.0%
14.1%
NM
14.2%
19.0%
-1.0%
NM
12.3%
15.9%
NM
6.7%
17.2%
7.8%
NM
22.8%
Source: Company reports and JPMorgan estimates.
151
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 89: EBAY Annual Balance Sheet
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
2,662.8
542.1
393.2
399.3
973.2
4,970.6
3,927.5
(453.9)
482.4
614.0
1,396.4
5,966.5
6,939.4
(453.9)
559.2
711.7
1,396.4
9,152.8
10,330.7
(453.9)
649.7
826.9
1,396.4
12,749.9
277.9
998.2
7,227.3
20.1
13,494.0
455.3
1,069.6
6,822.9
87.3
14,401.6
455.3
909.6
6,822.9
87.3
17,427.9
455.3
749.6
6,822.9
87.3
20,865.0
Liabilities and stockholders' equity
Accounts payable
Funds payable
Deferred Revenue
Short term debt
Taxes payable
Other current liabilities
Total current liabilities
83.4
1,160.0
129.0
464.4
681.7
2,518.4
131.6
1,535.1
153.5
101.2
1,319.6
3,241.0
152.5
1,779.2
177.9
101.2
1,319.6
3,530.4
177.2
2,067.3
206.7
101.2
1,319.6
3,872.1
Debt
Deferred taxes
Other long term
Total liabilities
31.8
39.2
2,589.4
592.4
48.9
3,882.2
10,519.3
14,401.6
592.4
48.9
4,171.7
13,256.2
17,427.9
592.4
48.9
4,513.3
16,351.6
20,865.0
Assets
Cash and cash equivalents
ST investments in marketable securities
Accounts receivable, net
Funds receivable
Other assets
Total current assets
Investments
Property and equipment, net
Intangible assets, net
Other assets, net
Total assets
Stockholders' equity:
Common stock
Accumulated deficit
Other equity
Total stockholders' equity
Total L&S
Source: Company reports and JPMorgan estimates.
152
10,904.6
13,494.0
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 90: EBAY Annual Cash Flow Statement
$ in millions
FY
2006A
FY
2007E
FY
2008E
FY
2009E
OPERATING CASH FLOWS
Net Income
Depreciation
Amortization
Stock based comp expense related to stock options and purchases
Tax Benefit
Excess tax benefit from stock-based compensation
Impairment
Minority Interest
Doubtful Accounts/Losses
Other
Changes in Working Capital
Accounts Receivable
Fund Receivable
Other
Deferred Tax
Accounts Payable
Funds Payable
Accrued Charges
Deferred Revenue
Income Taxes
Cash From Operations
% Chg Y-Y
1,125.6
544.6
317.4
148.6
(161.4)
0.0
227.2
(23.2)
(169.8)
(146.9)
(433.4)
(181.1)
33.0
575.1
(31.0)
47.9
283.0
2,247.8
11.8%
271.8
601.9
317.2
192.9
1,916.8
640.0
340.0
120.0
2,275.5
640.0
340.0
120.0
257.7
1,390.9
(399.8)
(157.60)
(212.32)
(516.08)
(68.93)
45.57
358.72
2.97
24.80
123.08
2,563.5
14.0%
200.0
(34.9)
(76.73)
(97.66)
20.93
94.14
24.41
3,181.9
24.1%
200.0
(14.2)
(90.56)
(115.26)
24.70
138.14
28.81
3,561.3
11.9%
FCF
% Chg Y-Y
1,732.3
3.6%
2,067.5
19.3%
2,611.9
26.3%
3,001.3
14.9%
INVESTING CASH FLOWS
Capital Expenditures
Net Investment
ST Investment Purch.
ST Investments Mat.
Acquisitions
Purchase of intangibles and other non current assets
Cash From Investing
(515.4)
797.0
(43.9)
(8.8)
228.9
(496.0)
48.5
(320.2)
5.5
(762.2)
(570.0)
(570.0)
(560.0)
(560.0)
313.5
365.2
(1,666.5)
(1,260.7)
(1,170.7)
(736.5)
-
-
Foreign Exch Effects
Net Change In Cash
133.3
1,349.2
199.9
1,264.8
2,611.9
3,001.3
Cash at Beginning
Cash at End
1,313.5
2,662.7
2,662.7
3,927.5
3,927.5
6,539.4
6,539.4
9,540.7
FINANCING CASH FLOWS
Common Stock Issued
Excess tax benefit from stock-based compensation
Shares Repurchased
Payment of headquarters facility lease obligation
Long Term Debt
Cash From Financing
Source: Company reports and JPMorgan estimates.
153
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Expedia, Overweight ($32.56)
We are maintaining our Overweight rating on Expedia. We continue to see mid-teen
revenue growth in F’08 as the company benefits from its customer rewards program,
entrance into new international markets, and growth of its media and advertising arm.
As the business is somewhat counter-cyclical, we believe EXPE will benefit from the
increased available inventory and discounted pricing in a weakening US economy.
• We expect 2008 revenue growth to be driven by international market
expansion. We expect F’08 European gross bookings to grow 26% Y/Y to
$5.2B on top of F’07E growth of 38%. We believe that the company will focus
on expanding inventory into secondary and tertiary markets as well as on
expansion into Asia. We also believe as the company increases selection, it may
enjoy improved conversion rates.
• The Media and Advertising arm will become a more significant growth
driver. We see TripAdvisor and its related properties (BookingBuddy and
SmarterTravel) benefiting the company two-fold. First, the business will
contribute to top-line growth as TripAdvisor organic growth rates are currently
over 60% Y/Y. Secondly, the businesses serve as a hedge to increasing online
marketing costs and Expedia is now able to share in the upside of this.
• We expect OIBA margins to decline 70 bps in F’08. We believe management
will increase selling and marketing spend to increase its share. Technology and
content spend will also likely increase as the company protects its market share
through innovation. Finally, facilities expense is expected by the company to
increase by $16M in F’08 due to relocation expenses.
• 2008 Drivers. In our view, the following factors will drive EXPE shares in 2008:
(1) first full year of comping lower air revenues as a result of GDS
renegotiations, (2) increased int’l inventory, which should drive conversion and
market share gains, and (3) rising travel marketing spend on media and
advertising unit.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $642.8M, $177.0M, and $0.24 (Y/Y growth of 21%, 11%, and
21% respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 91: Expedia Financial Snapshot
$ in millions, except per share data
Expedia
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
642.76
176.98
0.24
2,642.77
724.63
0.96
3,006.30
807.71
1.17
3,317.53
887.16
1.36
18.1%
18.8%
38.0%
13.8%
11.5%
21.4%
10.4%
9.8%
16.1%
642.86
182.09
0.24
2,646.54
719.62
0.96
3,019.64
820.34
1.19
3,367.52
945.01
1.55
14.1%
14.0%
24.0%
11.5%
15.2%
30.3%
Source: JPMorgan estimates, Company data, and Bloomberg
154
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We are adjusting our F’08 revenue estimate to $3.01B and our full-year EPS estimate
to $1.17, representing Y/Y revenue and EPS growth of 14% and 21%. We expect
most of the revenue growth to be driven by the international market where we see
gross bookings growth of 26% Y/Y. Furthermore, we note that this is the first year
that the company is fully comping air revenue declines as a result of GDS
renegotiations. Thus, the company faces easy domestic comparisons with 1H’07
gross bookings growth of only 4.5% Y/Y vs. 3Q’07 growth of 13.4%. We expect
OIBA margins to decline 70 bps in F'08 due to increased selling and marketing and
technology and content expenses and a one-time expense associated with relocation.
Figure 83: Domestic Unique Visitor Trends on EXPE Properties
thousands
21,500
16,500
11,500
6,500
1,500
Sep- Oct- Nov - Dec- Jan- Feb- Mar- Apr- May - Jun-
Jul- Aug- Sep- Oct- Nov -
2006 2006 2006 2006 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007
EXPEDIA.COM*
Tripadv isor Sites
HOTELS.COM
HOTWIRE.COM
Source: comScore and JPMorgan estimates
Our Estimates and Outlook for 2009
We are introducing F’09 revenue and EPS estimates of $3.32B and $1.36, which
represents 10% and 16% Y/Y growth, respectively. Again, we expect much of the
revenue growth to stem from European gross booking increases, which we model as
slowing to 18% on a Y/Y basis due to maturation of the market and increased
competition. Domestically, we expect Y/Y gross booking growth to slow to 5%
from 8% in the prior year, due to lower growth in shifts from offline spend and
increased competition. We expect OIBA margins to decrease another 10 bps Y/Y as
selling and marketing expenses rise.
Valuation and Rating Analysis
We believe Expedia is undervalued given the potential for international growth, signs
of a successful domestic turnaround, and increased advertising revenue opportunities.
On an EV/EBITDA basis, Expedia trades at 12.8x our F’08 EBITDA estimate of
$808 million, versus its peers at 19.1x. As such, we rate the stock Overweight.
Risks to Our Rating
The company’s shares could underperform if the company is unable to (1) withstand
the competitive threat that the travel suppliers and travel search engines pose, (2)
achieve a high ROI on selling and marketing investments, (3) successfully complete
the turnaround of the core Expedia brand, and (4) achieve further expansion into
international markets.
155
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 92: EXPE Annual Income Statement
$ in millions, except per share data
INCOME STATEMENT
North America
Europe
Other
Total Gross Bookings
% North America
% Europe
% Other
2006
12,737
3,001
1,424
17,162
74%
17%
8%
2007E
13,814
4,130
1,786
19,730
70%
21%
9%
2008E
14,887
5,205
2,101
22,194
67%
23%
9%
2009E
15,632
6,163
2,398
24,192
65%
25%
10%
Y/Y Growth
North America
Europe
Other
Total GB
5.6%
19.3%
46.5%
10.4%
8.5%
37.6%
25.4%
15.0%
7.8%
26.0%
17.6%
12.5%
5.0%
18.4%
14.1%
9.0%
Total Revenue
Revenue as a % GB
2,237.6
13.0%
2,642.8
13.4%
3,006.3
13.5%
3,317.5
13.7%
Cost of Revenues
Gross Profit
Gross Margin
494.2
1,743.3
78%
548.9
2,093.9
79.2%
623.7
2,382.6
79.3%
682.7
2,634.8
79.4%
Selling and Marketing expense
General and Administrative expense
Technology and Content
Amortization of non-cash distributing & mktg
Amortization of non-cash compensation expense
Amortization of intangibles
Stock Based Compensation
Depreciation expense
Extraordinary Items
Total Operating Expenses
Total Operating Expenses (Pro forma)
770.3
252.8
121.3
9.6
110.8
80.3
9.0
47.0
1,392.0
1,144.3
973.7
293.3
160.7
77.9
62.2
-
1,116.5
331.3
197.1
64.0
65.0
-
1,242.3
360.9
222.5
60.0
65.0
-
1,567.8
1,427.6
1,773.9
1,644.9
1,950.7
1,825.7
Operating Profit
Operating Profit (Pro forma)
Operating Margin
Operating Margin (Pro forma)
351.3
599.0
15.7%
26.8%
526.1
666.2
19.9%
25.2%
608.7
737.7
20.2%
24.5%
684.2
809.2
20.6%
24.4%
EBITDA
OIBA
OIBA Margin
609.8
599.0
26.8%
724.6
666.2
25.2%
807.7
737.7
24.5%
887.2
809.2
24.4%
Net Interest Income
Write-off of long-term investment
Other
Equity Income of Unconsolidated Affiliates
14.8
18.8
-
(6.3)
(13.5)
-
-
-
EBT (Earnings Before Taxes)
EBT (Earnings Before Taxes - Pro forma)
384.9
613.8
506.3
659.9
608.7
737.7
684.2
809.2
Minority Interest Income
Income Tax Expense
Tax Rate
Net Income (Reported)
Net Income (Pro Forma)
(0.5)
(139.5)
35%
244.9
388.5
1.3
(202.6)
40%
305.0
395.6
2.0
(243.5)
40%
367.2
442.6
2.0
(260.0)
38%
426.2
501.7
EPS (Reported)
EPS (Pro Forma)
Sharecount
0.70
1.10
352.2
0.96
1.23
317.7
1.17
1.39
314.0
1.36
1.58
314.0
Source: Company reports and JPMorgan estimates.
156
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 93: EXPE Quarterly Income Statement
$ in millions, except per share data
North America
Europe
Other
Total Gross Bookings
% North America
% Europe
% Other
1Q'06
3,522
780
347
4,649
76%
17%
7%
2Q'06
3,445
752
368
4,565
75%
16%
8%
3Q'06
3,104
792
365
4,261
73%
19%
9%
4Q'06
2,666
677
344
3,687
72%
18%
9%
1Q'07
3,559
1,032
425
5,016
71%
21%
8%
2Q'07
3,723
1,035
466
5,224
71%
20%
9%
3Q'07
3,519
1,163
465
5,147
68%
23%
9%
4Q'07E
3,013
900
430
4,343
69%
21%
10%
1Q'08E
3,915
1,334
507
5,756
68%
23%
9%
2Q'08E
3,984
1,306
550
5,840
68%
22%
9%
3Q'08E
3,765
1,457
545
5,768
65%
25%
9%
4Q'08E
3,223
1,108
499
4,830
67%
23%
10%
Y/Y Growth
North America
Europe
Other
Total GB
10.3%
12.7%
72.6%
13.8%
7.5%
12.4%
41.5%
10.5%
2.0%
23.0%
46.6%
8.2%
1.6%
32.7%
31.3%
8.6%
1.1%
32.3%
22.5%
7.9%
8.1%
37.6%
26.6%
14.4%
13.4%
46.8%
27.4%
20.8%
13.0%
33.0%
25.0%
17.8%
10.0%
29.3%
19.2%
14.8%
7.0%
26.2%
18.1%
11.8%
7.0%
25.3%
17.3%
12.1%
7.0%
23.0%
16.0%
11.2%
Total Revenue
Revenue as a % GB
493.9
10.6%
598.5
13.1%
613.9
14.4%
531.3
14.4%
550.5
11.0%
689.9
13.2%
759.6
14.8%
642.8
14.8%
644.7
11.2%
782.6
13.4%
859.4
14.9%
719.6
14.9%
Cost of Revenues
Gross Profit
Gross Margin
116.1
377.8
76.5%
126.9
471.6
78.8%
131.3
482.7
78.6%
120.0
411.3
77.4%
120.4
430.1
78.1%
143.0
546.9
79.3%
150.5
609.1
80.2%
135.0
507.8
79.0%
141.2
503.5
78.1%
161.2
621.4
79.4%
170.2
689.3
80.2%
151.1
568.5
79.0%
Selling and Marketing expense
General and Administrative expense
Technology and Content
Amortization of non-cash distributing & mktg
Amortization of non-cash compensation expense
Amortization of intangibles
Stock Based Compensation
Depreciation expense
Extraordinary Items
Total Operating Expenses
Total Operating Expenses (Pro forma)
195.8
63.7
29.8
8.2
30.2
23.9
9.0
351.6
289.3
195.2
62.3
29.9
0.6
30.1
17.2
335.3
287.4
212.1
59.1
31.4
0.7
26.6
16.4
47.0
393.4
302.7
167.2
67.7
30.2
0.1
23.9
22.7
311.7
265.0
219.0
68.5
38.2
21.2
15.9
362.8
325.7
253.1
68.7
38.0
19.5
14.0
393.3
359.8
276.6
75.7
44.0
18.6
14.4
429.3
396.3
225.0
80.3
40.5
18.6
18.0
382.4
345.8
256.6
79.3
48.3
16.0
16.0
416.2
384.2
287.2
78.3
47.0
16.0
15.0
443.4
412.4
313.7
85.9
55.0
16.0
15.0
485.6
454.6
259.1
87.8
46.8
16.0
19.0
428.6
393.6
Operating Profit
Operating Profit (Pro forma)
Operating Margin
Operating Margin (Pro forma)
26.2
88.5
5.3%
17.9%
136.3
184.2
22.8%
30.8%
89.3
180.0
14.5%
29.3%
99.5
146.2
18.7%
27.5%
67.3
104.4
12.2%
19.0%
153.6
187.1
22.3%
27.1%
179.8
212.8
23.7%
28.0%
125.4
162.0
19.5%
25.2%
87.3
119.3
13.5%
18.5%
177.9
208.9
22.7%
26.7%
203.6
234.6
23.7%
27.3%
139.9
174.9
19.4%
24.3%
EBITDA
OIBA
OIBA Margin
108.6
88.5
17.9%
195.8
184.2
30.8%
146.2
180.0
29.3%
159.2
146.2
27.5%
118.8
104.4
19.0%
200.7
187.1
27.1%
228.1
212.8
28.0%
177.0
162.0
25.2%
136.3
119.3
18.5%
225.9
208.9
26.7%
252.6
234.6
27.3%
192.9
174.9
24.3%
1.7
6.6
4.8
1.7
(3.9)
0.7
(1.1)
(2.0)
-
-
-
-
Net Interest Income
Write-off of long-term investment
157
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
1Q'06
3.7
-
2Q'06
10.5
-
3Q'06
2.9
-
4Q'06
1.7
-
1Q'07
(5.5)
2Q'07
5.9
3Q'07
(13.9)
4Q'07E
1Q'08E
2Q'08E
3Q'08E
4Q'08E
Other
Equity Income of Unconsolidated Affiliates
EBT (Earnings Before Taxes)
EBT (Earnings Before Taxes - Pro forma)
31.6
90.2
153.3
190.8
97.1
184.9
103.0
147.9
57.9
100.5
160.2
187.7
164.8
211.8
123.4
160.0
87.3
119.3
177.9
208.9
203.6
234.6
139.9
174.9
Minority Interest Income
Income Tax Expense
Tax Rate
Net Income (Reported)
Net Income (Pro Forma)
1.4
(9.7)
31%
23.3
57.0
(1.6)
(56.2)
37%
95.5
118.2
(0.4)
(37.7)
39%
59.0
117.2
0.1
(35.9)
35%
67.1
96.2
0.5
(23.6)
41%
34.8
59.3
0.0
(64.1)
40%
96.1
114.0
0.3
(65.5)
40%
99.6
123.1
0.5
(49.3)
40%
74.5
99.2
0.5
(34.9)
40%
52.9
71.6
0.5
(71.2)
40%
107.3
125.4
0.5
(81.5)
40%
122.7
140.8
0.5
(55.9)
40%
84.4
104.9
EPS (Reported)
EPS (Pro Forma)
Sharecount
0.06
0.15
365.2
0.27
0.32
359.1
0.17
0.34
341.1
0.20
0.28
343.6
0.11
0.18
323.7
0.30
0.35
320.2
0.32
0.39
312.8
0.24
0.31
314.0
0.17
0.23
314.0
0.34
0.39
314.0
0.39
0.44
314.0
0.27
0.33
314.0
Source: JPMorgan estimates and Company report
158
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 94: EXPE Annual Balance Sheet
$ in millions
2006
2007E
2008E
2009E
ASSETS
Cash and Cash Equivalents
Restricted Cash and Cash Equivalents
Marketable Securities
Accounts and Notes Receivable
Receivables from IAC and Subsidiaries
Deferred Income Taxes
Other Current Assets
Total Current Assets
853.3
11.1
211.4
4.9
102.0
1,182.7
501.4
20.7
317.9
0.3
143.3
983.6
1,361.2
23.0
417.9
0.3
183.3
1,985.7
2,306.4
23.0
509.9
0.3
223.3
3,062.9
Goodwill
Intangible Assets, Net
Long-Term Investments and Other
Property, Plant and Equipment, Net
Total Assets
5,861.3
1,028.8
59.3
137.1
8,269.2
5,912.9
988.5
89.0
152.9
8,127.0
5,912.9
988.5
89.0
189.2
9,165.4
5,912.9
988.5
89.0
228.1
10,281.5
720.7
466.5
10.3
30.9
171.7
1,400.1
500.0
4.7
369.3
29.0
61.8
1,864.9
849.0
549.5
13.8
52.5
196.9
1,661.6
500.0
500.0
104.1
362.4
62.6
3,190.6
1,219.0
719.5
13.8
52.5
196.9
2,201.6
500.0
500.0
104.1
362.4
62.6
3,730.6
1,629.0
874.5
13.8
52.5
196.9
2,766.6
500.0
500.0
104.1
362.4
62.6
4,295.6
INVESTED EQUITY
Invested Capital
Accumulated Other Comprehensive Income
Total Invested Equity
5,904.3
4,936.3
5,434.7
5,985.9
LIABILITIES AND INVESTED EQUITY
8,269.2
8,127.0
9,165.4
10,281.5
LIABILITIES
Accounts Payable, Trade
Deferred Merchant Bookings
Deferred Revenue
Income Tax Payable
Deferred income taxes
Short term borrowings
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Credit Facility
Other Long-Term Liabilities
Deferred Income Taxes
Derivative liabilities
Minority Interest
Total Liabilities
Source: Company reports and JPMorgan estimates.
159
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 95: EXPE Annual Cash Flow Statement
$ in millions
2006
2007E
2008E
2009E
CASH FLOW FROM OPERATIONS
Net Income
Adjustments to Reconcile Cash to Income
Depreciation and Amortization
Amortization of non-cash distributing & mktg
Amortization of non-cash compensation expense
Amortization of intangibles & stock-based comp
Deferred Income Taxes
Unrealized gain on derivative instrument
Equity in Losses of Unconsolidated Affiliates
Minority Interest in Income of Subsidiaries
Other
Impairment of Intangible Asset
Foreign exchange gain/loss
Changes in Current Assets and Current Liabilities
Accounts and Notes Receivable
Prepaids and Other Assets
Accounts Payable and Accrued Liabilities
Accounts Payable, merchants
Deferred Revenue
Deferred Merchant Bookings
Other, Net
Net Cash Provided by Operating Activities
244.9
48.8
200.7
(10.7)
(8.1)
(2.5)
0.5
1.1
47.0
(37.2)
(32.1)
(20.7)
59.9
63.2
3.2
59.5
617.4
305.0
58.4
140.2
(3.3)
5.9
4.1
(1.1)
3.4
(18.7)
(94.4)
(38.7)
(6.1)
221.1
3.4
83.0
662.2
367.2
70.0
129.0
1.2
(1.2)
(100.0)
(40.0)
140.0
230.0
170.0
966.2
426.2
78.0
125.0
1.2
(1.2)
(92.0)
(40.0)
160.0
250.0
155.0
1,062.1
Free Cash Flow (FCF)
524.8
565.6
859.9
945.2
CASH FLOW FROM INVESTING
Acquisitions, Net of Cash Required
Capital Expenditures
Purchase of Marketable Securities
Proceeds from Sale of Marketable Securities
Increase in Long-Term Investments & Notes Rec.
Proceeds from Sale of Business
Other, Net
Net Cash Provided by Investing Activities
(32.5)
(92.6)
(1.5)
13.2
(113.5)
(59.6)
(96.6)
(29.7)
(185.9)
(106.3)
(106.3)
(116.9)
(116.9)
CASH FLOW FROM FINANCING
Transfers to IAC
Short term borrowings
Proceeds from issuance of long term debt
Proceeds from Sale of Subsidiary Stock, inc. Options
Changes in Restricted Cash
Principal payments on long term obligations
Treasury stock activity
Other, Net
Net Cash Provided by Investing Activities
(231.0)
495.3
36.6
4.6
(295.7)
9.8
500.0
48.1
(10.6)
(1,396.0)
(0.8)
(859.4)
-
-
Effect of FX on Cash & Equivalents
Net Increase in Cash & Equivalents
42.1
555.9
31.2
(351.9)
859.9
945.2
Cash & Equivalents at Beginning of Period
Cash & Equivalents at End of Period
297.4
853.3
853.3
501.4
501.4
1,361.2
1,361.2
2,306.4
Source: Company reports and JPMorgan estimates.
160
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Google, Overweight ($710.84)
We believe Google will continue to innovate at an industry-leading pace, which
should spur continued market share gains. Additionally, international, which we are
modeling to be up 42% in 2008, will continue to be an important theme. At 37.7x our
F’08 GAAP EPS estimate of $18.94, we find Google’s valuation attractive. As such,
we maintain our Overweight rating.
• Volume growth and market share gains are likely. We think that paid clicks
will grow 30% Y/Y as search volume increases and as Google continues to take
market share. In addition to market share gain, coverage is expected to be up
slightly (~40 bps) and relevancy is expected to be up high single digits.
• International will be a more significant contributor in 2008. We believe
Google’s vast international presence will enable the company to maintain
industry-leading growth rates in 2008. We expect international gross revenues to
reach almost 50% of total revenues in 2008, growing 42% Y/Y. We believe
Western Europe will continue to outpace domestic growth. We believe
monetization will be a key catalyst for international growth in 2008, as
advertisers increasingly adopt paid search as a marketing vehicle.
• Google apps will begin to ramp. We think web-based cloud computing will
become more widely adopted in F’08 as it gains more mainstream appeal.
Additionally, Google's introduction of a complete services package, including
word processing, spreadsheets, and presentation capabilities for free, will likely
appeal to customers. We estimate that the office productivity software market is
~$10.3B. Even a 10% market share would mean an additional $1B in revenue to
Google.
• 2008 Drivers. In our view, the following factors will drive GOOG shares in
2008: (1) continued monetization enhancements of search & contextual
advertising platforms, (2) increased search market share, and (3) outsized growth
in Western Europe and emerging markets.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $3.45B, $2.01B, and $3.82 (Y/Y growth of 55%, 45%, and
16%, respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 96: GOOG Estimates Snapshot
$ in millions, except per share data
Google
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
3,447.35
2,013.12
3.82
11,718.63
6,957.86
13.33
16,957.04
9,917.13
18.94
22,332.26
12,646.53
24.38
60.6%
50.9%
34.0%
44.7%
42.5%
42.1%
31.7%
27.5%
28.7%
3,453.65
2,039.15
3.84
11,649.28
6,997.77
13.36
16,406.75
9,684.73
17.97
21,279.55
12,522.79
22.75
40.8%
38.4%
34.5%
29.7%
29.3%
26.6%
Source: JPMorgan estimates, Company reports, and Bloomberg
161
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We are raising our 2008 net revenue, EBITDA, and GAAP EPS estimates to
$16.96B, $9.92B, and $18.94 from $16.30B, $9.58B, and $18.18. Our new estimates
call for Y/Y revenue, EBITDA, and EPS growth of 45%, 43%, and 42%,
respectively.
In 2008, we are expecting Google to continue to make progress on the international
front, both through search volume growth and increasing advertiser demand. We are
modeling international gross revenue growth of 42% Y/Y to $11.1B in 2008. As we
believe international growth will outpace domestic growth, we see international
revenues representing ~49.4% of gross revenues in 2008, up from ~47.6% of gross
revenue in 2007. We believe usage will be the most meaningful catalyst for
international growth in 2008, as consumers in emerging markets continue to leverage
the Internet at an accelerating pace
Beyond international, we believe Google will generate above-average market share
growth through continued volume share gains from its domestic competitors. We
continue to believe that Google has the strongest brand in search. Google’s rapid
innovation of new web offerings should lead to increased attention from consumers,
which should contribute to sustained volume share growth in 2008. We think that
paid clicks will grow 30% Y/Y as search volume increases and as Google continues
to take market share.
We believe that Google’s attempts to show meaningful revenue diversification are
starting to come to fruition. We think web-based cloud computing will become more
widely adopted in F’08 as it gains more mainstream appeal. Additionally, Google's
introduction of a complete services package, including word processing,
spreadsheets, and presentation capabilities for free, will likely appeal to customers.
The product has become even more marketable to enterprise clients through the
acquisition of Postini, an on-demand security and compliance solution. We estimate
that the office productivity software market is ~$10.3B. Even a 10% market share
would mean an additional $1B in revenue to Google.
Our Estimates and Outlook for 2009
We are introducing above consensus 2009 estimates, which call for Y/Y revenue,
EBITDA, and EPS growth of 32%, 27.5%, and 29%, respectively. Specifically, our
F’09 revenue, EBITDA, and EPS estimates are $22.3B, $12.6B, and $24.38,
respectively.
In 2009, we are expecting search revenues to continue to show strong growth, despite
decelerating from 2008 levels. We are modeling Google.com search volumes to
grow ~25% in 2009, with RPM growth contributing an additional 8%. We believe
international search revenues will make up 51% of total company revenues in 2009.
Valuation and Rating Analysis
We believe GOOG shares are fundamentally attractive due to secular industry
growth trends, improving fundamentals in the international market, and expansion of
new product categories, such as contextual ad and local search. Google remains an
Overweight pick. Google trades at 21.4x its F’08E EBITDA vs. its large cap Internet
162
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
peers at 18.0x. Given Google's higher growth rate, we think it deserves a premium.
Hence, our OW rating.
Risks to Our Rating
Google has experienced very fast revenue growth over the past few years. Our
Overweight rating is based on the assumption that Google will continue to be the
market leader in the paid search space and will continue to enjoy strong revenue
growth. If the content publishers like Yahoo! and Microsoft are able to gain market
share through user defection from Google’s user base, then our rating could be too
optimistic. However, we have not seen any trends that would support this argument
thus far.
Our Overweight rating is also predicated on the company’s success in the
international market. If the company cannot successfully build out a larger
international advertising base, it will not be able to increase its monetization rate
abroad. Additionally, as Google continues to expand its business internationally, it
may face regulatory hurdles that make the business climate less hospitable and
potentially less profitable than the markets in which it currently operates.
163
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 97: GOOG Annual Income Statement
$ in millions, except per share data
FY
2006
10,604.9
3,308.8
79.5%
FY
2007E
16,455.1
4,736.5
84.6%
FY
2008E
22,479.5
5,522.5
85.9%
FY
2009E
28,531.9
6,199.7
86.2%
Google websites
Google Network websites
Licensing and other Revenues
Net Revenues
Y/Y growth
Q/Q growth
6,332.8
851.1
112.3
7,296.1
81.3%
10,709.2
861.4
148.0
11,718.6
60.6%
15,840.7
906.4
210.0
16,957.0
44.7%
21,040.7
996.6
295.0
22,332.3
31.7%
Cost of Revenues
Gross Profit
Gross Margins
Contribution GM
898.6
6,397.5
87.7%
1,722.4
9,996.2
85.3%
2,800.2
14,156.9
83.5%
3,822.7
18,509.6
82.9%
941.1
790.1
628.2
-
1,542.7
1,331.5
1,127.9
2,220.2
1,831.4
1,572.2
-
2,924.5
2,411.9
2,070.7
-
458.1
30.0
-
818.3
-
880.0
-
Total Expenses
3,746.1
6,542.8
9,303.9
880.0
12,109.7
Operating Income
Pro Forma Operating Income
Operating Margins
Pro Forma Operating Margins
Interest Income (Expense)
EBT
Less Taxes
Tax Rate
3,550.0
4,008.1
48.7%
54.9%
461.0
4,011.0
933.6
23%
5,175.8
5,994.1
44.2%
51.2%
582.3
5,758
1,534
27%
7,653.1
8,533.1
45.1%
50.3%
740.0
8,393
2,182
26.0%
10,222.5
11,102.5
45.8%
49.7%
740.0
10,963
2,850
26.0%
EBITDA
Margins
4,610.0
63.2%
6,957.9
59.4%
9,917.1
58.5%
12,646.5
56.6%
EAT
Tax Benefit --> Stock Comp & Foundation
Pro forma EAT
3077.4
225.3
3278.9
4,224.1
154.4
4,888.0
6,210.9
228.8
6,862.1
8,112.3
228.8
8,763.5
GAAP EPS
Pro forma EPS
9.94
10.59
13.33
15.42
18.94
20.92
24.38
26.33
Diluted Sharecount
309.5
317.0
328.0
332.8
Gross Revenue
TAC
TAC %
R&D
Sales & Marketing
General & Administrative
Cost of revenues
Research and development
Sales and marketing
General and administrative
In process R&D charge
Stock based compensation
Settlement Attorney Fees (Lane's Gift)
Contribution to Google Foundation
Source: Company reports and JPMorgan estimates.
164
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 98: GOOG Quarterly Income Statement
$ in millions, except per share data
Gross Revenue
TAC
TAC %
Q1 -06
2,253.8
722.7
77.8%
FY2006
Q2-06
Q3-06
2,456.0
2,689.7
785.2
825.3
78.8%
79.6%
Q4-06
3,205.5
975.6
81.4%
Q1 -07
3,664.0
1,125.0
83.6%
FY2007E
Q2-07
Q3-07
3,872.0
4,231.4
1,150.0
1,221.0
85.1%
83.9%
Q4-07E
4,687.8
1,240.4
85.8%
Q1 -08E
5,229.3
1,355.5
85.8%
FY 2008E
Q2-08E
Q3-08E
5,366.3
5,615.3
1,355.0
1,358.2
85.8%
86.0%
Q4-08E
6,268.5
1,453.8
86.0%
Google websites
Google Network websites
Licensing and other Revenues
Net Revenues
Y/Y growth
Q/Q growth
1,297.3
205.6
28.1
1,531.0
92.7%
18.7%
1,432.5
211.4
27.0
1,670.8
87.6%
9.1%
1,626.0
211.8
26.7
1,864.4
77.8%
11.6%
1,977.0
222.2
30.6
2,229.9
72.8%
19.6%
2,282.1
220.3
36.5
2,538.9
65.8%
13.9%
2,486.3
202.1
33.6
2,722.0
62.9%
7.2%
2,734.8
233.7
41.9
3,010.4
61.5%
10.6%
3,206.1
205.3
36.0
3,447.4
54.6%
14.5%
3,604.4
224.3
45.0
3,873.8
52.6%
12.4%
3,737.0
224.3
50.0
4,011.3
47.4%
3.5%
3,981.1
221.1
55.0
4,257.2
41.4%
6.1%
4,518.1
236.7
60.0
4,814.8
39.7%
13.1%
Cost of Revenues
Gross Profit
Gross Margins
Contribution GM
179.1
1,351.9
88.3%
87.0%
201.6
1,469.3
87.9%
87.4%
221.3
1,643.1
88.1%
88.1%
296.7
1,933.2
86.7%
84.0%
341.0
2,197.9
86.6%
83.9%
402.6
2,319.4
85.2%
80.9%
437.5
2,572.8
85.5%
81.1%
541.2
2,906.1
84.3%
79.9%
627.6
3,246.2
83.8%
78.5%
661.9
3,349.4
83.5%
79.9%
706.7
3,550.5
83.4%
78.4%
804.1
4,010.7
83.3%
80.8%
R&D
Sales & Marketing
General & Administrative
Cost of revenues
Research and development
Sales and marketing
General and administrative
In process R&D charge
Stock based compensation
Settlement Attorney Fees (Lane's Gift)
Contribution to Google Foundation
173.5
175.0
116.0
212.0
182.1
150.7
250.9
192.3
168.7
304.7
240.7
192.8
287.6
275.3
230.0
375.1
319.2
278.9
418.1
350.9
288.0
461.9
386.1
330.9
511.3
418.4
360.3
529.5
433.2
373.1
553.4
459.8
395.9
625.9
520.0
443.0
114.7
30.0
-
109.1
-
99.9
-
134.4
-
183.9
-
241.5
-
198.0
-
195.0
-
205.0
-
215.0
-
225.0
-
235.0
-
Total Expenses
788.3
855.5
933.1
1,169.3
1,317.7
1,617.3
1,692.5
1,915.2
2,122.5
2,212.6
2,340.8
2,627.9
Operating Income
Pro Forma Operating Income
Operating Margins
Pro Forma Operating Margins
Interest Income (Expense)
EBT
Less Taxes
Tax Rate
742.7
887.4
49%
58%
67.9
811
218
27%
815.4
924.5
49%
55%
160.8
976
255
26%
931.3
1,031.2
50%
55%
108.2
1,040
306
29%
1,060.6
1,195.0
48%
54%
124.1
1,185
154
13%
1,221.2
1,405.1
48%
55%
130.7
1,352
350
26%
1,104.6
1,346.1
41%
49.5%
137.1
1,242
317
25%
1,317.8
1,515.8
44%
50.4%
154.4
1,472
402
27%
1,532.1
1,727.1
44%
50%
160.0
1,692
465
28%
1,751.3
1,956.3
45%
51%
170.0
1,921
500
26%
1,798.7
2,013.7
45%
50%
180.0
1,979
514
26%
1,916.4
2,141.4
45%
50%
190.0
2,106
548
26%
2,186.8
2,421.8
45%
50%
200.0
2,387
621
26%
EBITDA
Margins
998.5
65.2%
1,050.7
62.9%
1,176.5
63.1%
1,384.3
62.1%
1,610.1
63.4%
1,569.5
57.7%
1,765.2
58.6%
2,013.1
58.4%
2,266.3
58.5%
2,347.7
58.5%
2,499.4
58.7%
2,803.8
58.2%
165
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Q1 -06
592.3
39.8
697.2
Q2-06
721.1
(3.2)
772.1
GAAP EPS
Pro forma EPS
1.95
2.29
Diluted Sharecount
FY2006
FY2007E
Q2-07
Q3-07
925.1
1,070.0
43.0
31.0
1,123.6
1,236.9
Q3-06
733.4
20.9
812.3
Q4-06
1,030.7
167.8
997.3
Q1 -07
1,002.2
26.8
1,159.3
2.33
2.49
2.36
2.62
3.29
3.18
3.18
3.68
2.93
3.56
304.1
310.0
310.6
313.5
314.9
% of Revenue
Google website
Network Partners
R&D
Sales & Marketing
General & Administrative
85%
13%
11.3%
11.4%
7.6%
86%
13%
12.7%
10.9%
9.0%
87%
11%
13.5%
10.3%
9.0%
89%
10%
13.7%
10.8%
8.6%
Q/Q Growth
R&D
Sales & Marketing
General & Administrative
10%
13%
2%
22%
4%
30%
18%
6%
12%
Y/Y Growth
R&D
Sales & Marketing
General & Administrative
Total Expenses
Contribution Margins
218%
211%
203%
124%
54%
221%
188%
211%
106%
51%
192%
183%
182%
80%
53%
EAT
Tax Benefit --> Stock Comp & Foundation
Pro forma EAT
Source: Company reports and JPMorgan estimates.
166
FY 2008E
Q2-08E
Q3-08E
1,464.2
1,558.7
55.9
58.5
1,623.3
1,725.2
Q4-07E
1,226.8
53.6
1,368.2
Q1 -08E
1,421.7
53.3
1,573.4
Q4-08E
1,766.3
61.1
1,940.2
3.38
3.91
3.82
4.26
4.37
4.84
4.48
4.96
4.74
5.24
5.34
5.86
315.5
316.6
321.0
325.0
327.0
329.0
331.0
90%
9%
11.3%
10.8%
9.1%
91%
7%
13.8%
11.7%
10.2%
91%
8%
13.9%
11.7%
9.6%
93%
6%
13.4%
11.2%
9.6%
93%
6%
13.2%
10.8%
9.3%
93%
6%
13.2%
10.8%
9.3%
94%
5%
13.0%
10.8%
9.3%
94%
5%
13.0%
10.8%
9.2%
21%
25%
14%
-6%
14%
19%
30%
16%
21%
11%
10%
3%
10%
10%
15%
11%
8%
9%
4%
4%
4%
5%
6%
6%
13%
13%
12%
194%
156%
169%
62%
51%
166%
157%
198%
67%
51%
177%
175%
185%
89%
40%
167%
182%
171%
81%
42%
152%
160%
172%
64%
44%
178%
152%
157%
61%
41%
141%
136%
134%
37%
52%
132%
131%
137%
38%
50%
135%
135%
134%
37%
51%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 99: GOOG Annual Balance Sheet
$ in millions
Cash and Cash Equivalents
Short term investments
Accounts Receivable
Income taxes receivable
Deferred Income Tax
Prepaid revenue share,expenses and other assets
Total Current Assets
FY
2006E
3,544.7
7,699.2
1,322.3
29.7
443.9
13,039.8
FY
2007E
6,239.2
7,980.9
2,068.4
88.0
689.5
17,066.0
FY
2008E
11,914.1
7,980.9
2,888.9
88.0
963.0
23,834.8
Non-marketable equity securities
Property, Plant, and Equipment
Goodwill
Intangible Assets
Deferred income taxes, net
Prepaid revenue share, expenses and other non current assets
1,031.9
2,395.2
1,545.1
346.8
114.5
1,048.1
3,923.8
2,277.4
485.3
170.1
1,048.1
5,563.8
2,277.4
485.3
170.1
FY
2009E
19,650.4
7,980.9
3,702.0
88.0
1,234.0
32,655.2
1,048.1
7,043.8
2,277.4
485.3
170.1
Total Assets
18,473.4
24,970.7
33,379.5
43,679.9
Accounts Payable
Accrued Compensation and benefits
Accrued Expenses and other current liabilities
Accrued revenue share
Deferred revenue
Income taxes payable
Current portion of equipment leases
Total Current Liabilities
211.2
351.7
265.9
370.4
105.1
0.4
1,304.6
265.5
568.1
459.1
581.4
167.3
2,041.5
529.6
553.7
553.7
812.0
233.7
2,682.7
678.7
709.5
709.5
1,040.6
299.5
3,437.8
20.0
40.4
68.5
128.9
23.7
91.0
114.7
23.7
91.0
114.7
-
-
-
Common stock
Preferred stock
Additional Paid in capital
Note receivable from office/stockholder
Deferred stock based compensation
Accumulated other comprehensive income
Retained Earnings
Total Stockholders' equity
0.3
11,882.9
23.3
5,133.3
17,039.8
22,814.5
0
0
0
0
0
0
0
30,582.1
Total Liabilities & Equity
18,473.4
24,970.7
33,379.5
23.7
91.0
114.7
40,127.4
43,679.9
Long term portion of equipment leases
Deferred revenue, long term
Liability for stock options exercised early, long term
Deferred income taxes
Income taxes payable, long-term
Other long term liabilities
Total Long Term Liabilities
Redeemable convertible, preferred stock warrant
Source: Company reports and JPMorgan estimates.
167
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 100: GOOG Annual Cash Flow Statement
$ in millions
FY
2006E
FY
2007E
FY
2008E
FY
2009E
3,077.4
494.4
77.5
10.8
458.1
(581.7)
1.7
4,224.1
805.8
157.9
818.3
(238.6)
(7.2)
6,210.9
1,160.0
224.0
880.0
-
(624.0)
398.4
(289.2)
95.4
291.5
139.3
30.8
3,580.5
(559.4)
431.0
(237.3)
20.2
206.5
136.4
32.1
5,790.0
8,474.9
8,112.3
1,320.0
224.0
880.0
10,536.3
1,677.7
3,490.3
5,674.9
7,736.3
(1,902.8)
(26,681.9)
23,107.1
(1,019.1)
(402.4)
(6,899.2)
(2,299.6)
(11,756.1)
11,519.0
(21.3)
(823.1)
(3,381.2)
(2,800.0)
(2,800.0)
(2,800.0)
(2,800.0)
Financing Activities
Proceeds from issuance of convertible preference stock
Proceeds from IPO/Public Offering
Proceeds from exercise of stock options
Proceeds from exercise of warrants
Payments of notes receivables from shareholders
Excess tax benefits from stock-based award activity
Payment of Principal on capital leases and eqpt loans
Net Cash provided by Financing Activities
2,063.5
321.1
581.7
2,966.4
19.1
238.6
257.7
-
-
Effect of Exchange rate changes
Net Increase (Decrease) in Cash & Equivalents
19.7
(332.5)
28.1
2,694.5
5,674.9
7,736.3
Cash and Cash Equivalents - Beginning
Cash and Cash Equivalents - Ending
3,877.4
3,544.9
3,544.9
6,239.4
6,239.4
11,914.3
11,914.3
19,650.6
Operating Activities
Net income
Depreciation and Amortization
Amortization of Warrants
Amortization of Intangibles
In process R&D
Stock based compensation
Excess tax benefit from stock-based award activity
Other
Changes in WC
Accounts Receivables
Income taxes
Prepaid revenue share,expenses and other assets
Accounts Payable
Accrued Expenses and other liabilities
Accrued revenue share
Deferred revenue
Tax Benefit from exercise Option
Non Recurring Portion
Net Cash provided by Operating Activities
FCF
Investing Activities
Purchase of PP&E
Purchase of short term investments
Maturities and sale of short term investments
Investments in non-marketable equity securities
Acquisitions, net of cash acquired
Change in other assets
Net Cash used in Investing Activities
Source: Company reports and JPMorgan estimates.
168
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
HouseValues, Underweight ($2.94)
As HouseValues’ businesses continue to be in transition, we believe it is strategically
disadvantaged to weather the ongoing downturn in the real estate market. Despite a
strong balance sheet ($74.5M net cash at the end of 3Q’07), we believe the company
will continue to be impacted by weakness in the housing market and therefore
maintain our Underweight rating.
• Lead generation business – we expect ARPC to stabilize. As a result of the
housing slowdown, SOLD has been shedding costumers at a rapid clip, losing
1,559 customers in 3Q’07 alone. We believe that a large number of customers
lost were lower value customers. As a result, we expect ARPC to stabilize in
2008, at $410, from $403 in 2007.
• Acquisition of Realty Generator could provide some upside to our F'08
estimates. SOLD announced the acquisition of Realty Generator, a provider of
marketing and technology solutions to real estate brokerage companies, in
November ’07. While the acquisition was small, ~$10M, we expect it to be
accretive to EBITDA in F’08 and the acquisition demonstrates that management is
looking to diversify its product mix.
• Acquisitions could continue. With $74.5M in cash at the end of 3Q'07, and
slow real estate markets depressing valuations in the space, we expect
HouseValues’ to actively pursue acquisitions.
• 2008 share price catalysts. We will look for the following as signs of an
improving business model in 2008: (1) stabilization in ARPC, and (2) revenue
generation of the Realty Generator acquisition. We would be concerned if we
saw the following trends develop in 2008: (1) continued declines in ARPC, (2)
accelerating customer losses, and (3) continued declines in U.S. home sales.
• Tweaking 4Q estimates. We are maintaining our 4Q’07 revenue and
EBITDA estimates of $12.3M and $1.6M, and modifying our 4Q07 EPS
estimate from ($0.01) to $0.00.
The table below outlines our current estimates, including our newly introduced 2009
estimates.
Table 101: HouseValues Estimate Snapshot
$ in millions
HouseValues
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07
F'07
F'08
F'09
F'07 Y/Y
F'08 Y/Y
F'09 Y/Y
12.3
1.6
0.00
59.9
3.4
(0.09)
49.3
7.4
0.02
54.0
8.1
0.07
-36.7%
-56.7%
NM
-17.7%
118.6%
NM
9.6%
9.6%
376.1%
11.8
1.6
(0.02)
59.5
3.4
(0.10)
46.2
7.4
(0.07)
-
-37.1%
-56.6%
NM
-22.4%
117.6%
NM
NM
NM
NM
Source: Company reports, FactSet and JPMorgan estimates.
169
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Key Financial Metrics & Forecasts
The following table summarizes our estimates for HouseValues’ customer additions
and average revenue per real estate customer through 2008.
Table 102: SOLD Customer Metrics and ARPC Forecast
Real Estate Customers
Net Customer Additions
Y/Y growth
Average Revenue per Real Estate Customer
ARPC Growth Y/Y
2005
15,700
5,068
46.1%
489.25
10.4%
2006
14,596
(375)
-2.3%
446.5
-8.7%
2007E
9,948
(5,745)
-36.6%
402.8
-9.8%
2008E
10,448
500
5.0%
410
1.7%
2009E
11,648
1,200
11.5%
408
-0.5%
Source: Company Reports and JPMorgan estimates
Our Estimates and Outlook for 2008
Our updated 2008 estimates call for a Y/Y decline in revenues, down 17.7%, and
Y/Y improvements in EBITDA, up 118.6%, as a result of cost savings initiatives,
including the closing of a call center. Specifically, we are modeling 2008 revenues,
EBITDA, and EPS of $49.3M, $7.4M, and $0.02.
Our Estimates and Outlook for 2009
We are introducing 2009 estimates calling for revenue, EBITDA, and earnings of
$54M, $8.1M, and $0.07. These estimates incorporate the following assumptions: (1)
revenue per real estate subscriber will decline slightly in 2009, (2) a marginal
revenue impact from the acquisition of Realty Generator, and (3) sustained margin
improvements despite continued softness in the real estate market.
Valuation and Rating Analysis
On an EV/EBITDA basis, SOLD trades at 1.0x our F’08 EBITDA estimate of
$7.4M, vs. peers at 20.5x. Despite this discount, we remain very concerned about
SOLD’s longer-term growth outlook for two main reasons:
•
Even as the real estate market faces significant headwinds, the online real
estate sector continues to become more competitive, with current players
upgrading current offerings and new players entering the space.
•
Additionally, other players in the space with multiple product offerings have
introduced lead-generation products that supplement other real estate offerings
such as listing enhancement products. The company is likely to face increased
competition from players such as Move, Inc., Homegain, LendingTree,
ZipRealty, and Zillow as more advertising dollars shift online.
Therefore, we believe the current discount is justified and SOLD could continue to
face continued pressure on its cash balance and therefore, we maintain our
Underweight rating.
170
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
Our current estimates are based on the assumption that difficult real estate market
conditions will persist during 2007 and 2008, which could impact HouseValue’s top
and bottom lines. Inherent in our assumptions are continued customer churn and
limited upside potential in revenue per customer. Should market conditions improve
sooner than we anticipate, our estimates could prove to be too conservative.
171
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 103: SOLD Annual Income Statement
$ in millions, except per share data
FY
2006
FY
2007E
FY
2008E
FY
2009E
Revenues
House Values/Just Listed
Other
94.6
62.2
12.3
59.9
59.9
-
49.3
49.3
-
54.0
54.0
-
Sales & Marketing
Technology and Product Development
General & Admin
Restruc. / Impair't of goodwill + intang. assts
Depreciation
Amortization
Stock based compensation
Total Expenses
Total Recurring Expenses
61.8
13.0
12.0
38.7
8.7
9.1
30.3
6.0
5.5
33.2
6.6
6.1
5.2
1.1
4.0
97.0
86.8
5.3
0.7
3.2
67.0
56.5
6.0
1.6
2.1
51.6
41.9
3.6
2.0
3.2
54.6
45.9
Income from Operations
Pro Forma Operating Income
Operating Margins
Pro Forma Operating Margins
(2.4)
7.8
-2.6%
8.3%
(7.1)
3.4
-11.8%
5.7%
(2.3)
7.4
-4.6%
15.1%
(0.6)
8.1
-1.1%
15.1%
EBITDA
EBITDA Margins
Y/Y EBITDA Growth
7.8
8.3%
-67.5%
3.4
5.7%
-56.7%
7.4
15.1%
118.6%
8.1
15.1%
9.6%
Interest Income, Net
2.7
2.9
2.8
3.1
EBT
Tax
EAT (Continuing Operations)
Pro Forma EAT (excludes FAS)
(6.0)
(3.1)
(2.9)
6.8
(4.2)
(1.8)
(2.3)
4.1
0.5
0.1
0.4
6.6
2.5
0.6
1.9
7.3
Income/loss from Discontinued Ops
Income tax benefit from discontinued
Loss on discontinued ops
Net income - adj for discontinued
(0.4)
(0.1)
(0.3)
(3.1)
0.2
0.1
0.2
(2.2)
0.4
1.9
Weighted Average No of shares (diluted)
26.1
24.5
25.7
25.8
Pro Forma EPS
GAAP EPS
0.25
(0.14)
0.17
(0.09)
0.26
0.02
0.28
0.07
Source: Company reports and JPMorgan estimates.
172
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 104: SOLD Quarterly Income Statement
$ in millions, except per share data
Q1-06
Revenues
House Values/Just Listed
Other
23.2
Sales & Marketing
Technology and Product Development
General & Admin
Restruc. / Impair't of goodwill + intang. assts
Depreciation
Amortization
Stock based compensation
Total Expenses
Total Recurring Expenses
FY2006
Q2-06
Q3-06
Q4-06
Q1-07
FY2007E
Q2-07
Q3-07
Q4-07E
Q1-08E
FY2008E
Q2-08E
Q3-08E
Q4-08E
24.0
20.6
2.9
21.5
19.2
2.3
17.8
17.8
16.0
16.0
13.8
13.8
12.3
12.3
12.1
12.1
12.2
12.2
12.5
12.5
12.5
12.5
3.6
25.9
22.4
3.5
13.5
2.7
2.6
15.9
3.4
3.0
17.1
3.2
3.3
12.2
2.7
2.7
10.1
2.4
2.6
7.5
1.5
1.3
7.6
1.5
1.3
7.6
1.5
1.5
7.7
1.5
1.4
1.1
0.4
1.1
25.0
22.4
1.6
0.3
1.0
26.3
23.5
1.4
0.4
1.2
20.5
17.5
1.4
0.0
0.7
17.1
15.0
8.8
2.1
2.4
1.2
1.3
0.0
0.6
16.4
13.3
7.6
1.6
1.5
1.0
0.2
1.0
21.0
18.8
15.3
3.6
3.1
6.2
1.5
0.2
1.0
30.9
22.0
1.3
0.3
0.6
12.9
10.7
1.4
0.4
0.6
12.7
10.3
1.5
0.4
0.5
12.8
10.4
1.5
0.4
0.5
13.0
10.6
1.6
0.4
0.5
13.1
10.6
Income from Operations
Pro Forma Operating Income
Operating Margins
Pro Forma Operating Margins
2.2
4.4
9.6%
19.0%
0.9
3.5
3.3%
13.5%
(2.3)
0.4
-9.7%
1.8%
(9.4)
(0.5)
-43.5%
-2.3%
(2.7)
0.3
-15%
2%
(1.1)
0.9
-7%
6%
(2.6)
0.5
-19%
4%
(0.6)
1.6
-5%
13%
(0.7)
1.7
-5%
15%
(0.6)
1.8
-5%
15%
(0.5)
1.9
-4%
15%
(0.5)
2.0
-4%
16%
EBITDA
EBITDA Margins
Y/Y EBITDA Growth
4.4
19%
-12%
3.5
13%
-38%
0.4
2%
-94%
(0.5)
-2%
-107%
0.3
2%
-92%
0.9
6%
-73%
0.5
4%
17%
1.6
13%
-425%
1.7
15%
410%
1.8
15%
94%
1.9
15%
268%
2.0
16%
23%
Interest Income, Net
0.6
0.7
0.7
0.6
0.6
0.8
0.9
0.7
0.7
0.7
0.7
0.7
EBT
Tax
EAT (Continuing Operations)
Pro Forma EAT (excludes FAS)
2.8
0.8
2.0
3.3
1.6
(0.3)
1.9
2.7
(1.6)
(0.2)
(1.5)
0.7
(8.7)
(3.4)
(5.3)
0.1
(2.1)
(0.9)
(1.2)
0.6
(0.4)
(0.1)
(0.3)
1.1
(1.7)
(0.8)
(0.9)
0.9
0.1
0.0
0.1
1.5
0.0
0.0
0.0
1.6
0.1
0.0
0.1
1.6
0.2
0.0
0.1
1.7
0.2
0.0
0.1
1.7
Income/loss from Discontinued Ops
Income tax benefit from discontinued
Loss on discontinued ops
Net income - adj for discontinued
(0.4)
(0.1)
(0.3)
1.8
1.9
(1.5)
(5.3)
(0.1)
(0.0)
(0.0)
(1.2)
0.2
0.1
0.1
(0.2)
0.1
0.0
0.1
(0.9)
0.1
0.0
0.1
0.1
0.13
Weighted Average No of shares (diluted)
27.4
27.3
25.4
24.4
24.4
24.6
24.5
24.5
25.6
25.6
25.7
25.7
Pro Forma EPS
GAAP EPS
0.12
0.06
0.10
0.07
0.03
(0.06)
0.00
(0.22)
0.02
(0.05)
0.04
(0.01)
0.04
(0.04)
0.06
0.00
0.06
0.00
0.06
0.00
0.07
0.01
0.07
0.00
Source: Company reports and JPMorgan estimates.
173
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 105: SOLD Quarterly Income Statement
$ in millions, except per share data
Total Customers
Real Estate customers (QE)
Real Estate customers (Avg.)
Net Customer Additions
Sequential Growth
Y/Y growth
Average Reve/Sub
ARPC Growth Y/Y
ARPC Growth Q/Q
Churn
Lifetime Value of Customer
SAC
Total Sales and Marketing Dept
Expenses as % of Revenue
Sales & Marketing
Technology and Product Development
General & Admin
Depreciation
Amortization
Y/Y Change
Revenue Growth
Sales & Marketing
Technology and Product Development
General & Admin
Depreciation
Amortization
Total Expenses
Total Recurring Expenses
GAAP EPS
Sequential Change
Revenue Growth
Sales & Marketing
Technology and Product Development
General & Admin
Depreciation
Amortization
Source: Company reports and JPMorgan estimates.
174
FY2006
Q3-06
Q1-06
Q2-06
16,922
15,825
15,763
854
5%
30%
492
5.4%
-1.2%
6.6%
7,455
17,090
15,993
16,197
168
1%
22%
461
-5.5%
-6.3%
7.4%
6,230
17,281
16,184
16,089
191
1%
9%
427
-15.3%
-7.4%
7.6%
5618
389
427
450
58.2%
11.6%
11.2%
4.4%
0.9%
61.5%
13.3%
11.8%
4.3%
1.6%
71.2%
13.4%
13.6%
6.5%
1.1%
32%
57%
118%
-6%
186%
40%
56.4%
49.0%
26%
55%
114%
0%
178%
168%
58.9%
50.0%
-7.7%
-0.6%
9.1%
5.2%
61.2%
-33.9%
11.3%
17.6%
27.3%
17.2%
10.1%
89.7%
FY2007E
Q2-07
Q3-07
Q4-07E
Q1-08E
FY2008E
Q2-08E
Q3-08E
Q4-08E
9,948
9,948
10,298
(700)
-6.57%
-36.61%
398
-1.97%
1.27%
9,848
9,848
9,898
(100)
-1.01%
-32.52%
406
-2.17%
2.01%
9,948
9,948
9,898
100
1.02%
-25.23%
411
1.48%
1.23%
10,148
10,148
10,048
200
2.01%
-4.70%
415
5.60%
0.97%
10,448
10,448
10,298
300
2.96%
5.03%
406
2.01%
-2.17%
63.8%
15.0%
17.5%
9.3%
0.1%
62.0%
13.0%
12.0%
10.6%
2.4%
62.0%
12.5%
11.0%
11.6%
3.3%
62.0%
12.5%
10.5%
12.3%
3.3%
61.0%
12.0%
12.0%
12.0%
3.2%
61.0%
12.0%
11.3%
12.8%
3.2%
-38%
-36%
-31%
-16%
21%
-96%
-31.5%
-32.8%
-42%
-49%
-35%
-26%
-18%
-94%
-37.6%
-43.6%
-43%
-50%
-56%
-52%
-13%
53%
-58.2%
-51.4%
-32%
-39%
-44%
-50%
-1%
1%
-38.1%
-41.1%
-24%
-25%
-35%
-50%
11%
2400%
-25.4%
-31.0%
-9%
-13%
-28%
-38%
17%
2400%
-20.7%
-20.0%
2%
0%
-6%
-4%
23%
33%
1.4%
-1.2%
-10.4%
-16.8%
-11.8%
-3.9%
-4.2%
-95.9%
-13.7%
-13.1%
-12.1%
-5.6%
-5.5%
0.0%
-10.9%
-13.3%
-22.9%
-39.0%
1.6%
1775.0%
-2.0%
-2.0%
-5.7%
-10.1%
7.7%
33.3%
1.2%
1.2%
1.2%
-3.4%
7.1%
0.0%
2.5%
0.9%
-1.6%
17.1%
0.0%
0.0%
0.3%
0.3%
0.3%
-5.6%
6.7%
0.0%
Q4-06
Q1-07
15,693
14,596
15,390
(1,588)
-9.19%
-2.33%
406
-18.47%
-4.92%
9.3%
4,366
14,593
13,508
14,052
(1,100)
-7.01%
-13.76%
415
-15.65%
2.22%
10.4%
3,990
13,304
12,207
12,858
(1,289)
-8.83%
-22.15%
405
-12.15%
-2.41%
9.1%
4,451
10,648
10,648
11,428
(1,559)
-19.96%
-38.38%
393
-7.96%
-2.96%
9.5%
4,137
379
368
240
71.1%
16.9%
14.4%
6.9%
0.9%
68.2%
15.0%
14.9%
7.9%
2.2%
63.3%
14.8%
16.0%
8.5%
0.1%
3%
49%
86%
0%
208%
71%
51.2%
42.9%
-15%
12%
47%
25%
137%
-39%
56.2%
18.6%
-23%
-10%
-1%
2%
39%
85%
-2.2%
-7.0%
-7.3%
7.4%
-6.4%
6.7%
39.7%
-36.1%
-10.3%
-10.5%
13.0%
-4.9%
-4.6%
-24.0%
-17.1%
-20.5%
-26.3%
-13.8%
-5.0%
101.5%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 106: SOLD Annual Balance Sheet
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
ASSETS
Current assets:
Cash and cash equivalents
Short-term investments
Accounts receivable, net
Income taxes Receivable
Prepaid advertising
Prepaid expenses and other assets
Deferred income taxes
Prepaid income taxes
Other current assets
Total current assets
49.4
28.4
0.4
1.7
1.6
2.3
83.8
26.4
40.3
0.0
1.9
2.0
0.9
71.4
34.6
40.3
0.0
1.4
1.9
0.9
79.1
42.9
40.3
0.0
1.4
1.9
0.9
87.4
Property and equipment, net
Goodwill
Intangible assets, net
Restricted cash
Other assets
Deferred income taxes
Total assets
11.5
3.6
0.6
1.8
101.4
8.0
3.6
0.2
2.6
85.9
6.4
3.6
0.2
2.6
91.9
5.3
3.6
0.2
2.6
99.1
3.2
3.2
5.1
0.8
2.4
3.5
0.3
0.9
7.9
0.8
2.4
3.5
0.3
0.9
7.9
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable
Accrued compensation and benefits
Accrued expenses and other current liabilities
Deferred rent, current portion
Deferred revenue
Income taxes payable
Total Current Liabilities
1.1
12.9
1.0
1.9
2.5
0.3
0.8
6.5
Deferred income taxes
Deferred rent, less current portion
Note payable
Redeemable convertible preferred Series A
Redeemable convertible preferred Series B
Total Liabilities
1.1
1.7
15.7
0.8
1.8
9.1
0.8
1.8
10.5
0.8
1.8
10.5
Shareholders Equity:
Common stock
Deferred stock-based compensation
Notes receivable from officers/shareholders
Retained earnings
Total shareholders equity
Total Liabilities and shareholders equity
63.2
22.4
85.7
101.4
56.5
20.3
76.8
85.9
60.7
20.7
81.4
91.9
66.1
22.5
88.6
99.1
Source: Company reports and JPMorgan estimates.
175
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 107: SOLD Annual Statement of Cash Flows
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
(3.1)
5.2
1.3
4.1
(3.5)
(2.2)
5.3
0.7
3.2
(1.1)
0.4
6.0
1.6
2.1
-
1.9
5.9
1.6
3.2
-
1.1
0.2
0.8
1.9
0.5
(0.2)
0.5
1.0
0.1
12.0
533.7%
12.6
4.6%
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
Operating activities:
Depreciation and amortization of property and equipment
Amortization of intangible assets
Stock-based compensation
Deferred income tax expense (benefit)
Impairment of goodwill and intangible assets
Tax benefit from exercise of stock option
Changes in certain assets and liabilities, net of Soar Solutions, Inc acquisition
Accounts receivable
Prepaid advertising
Prepaid expenses and other assets
Prepaid income taxes
Other current assets
Income taxes receivable
Accounts payable
Accrued compensation and benefits
Accrued expenses and other current liabilities
Deferred rent
Deferred revenue
Income taxes payable
Net cash provided by operating activities
Y/Y Growth in OCF
(0.6)
0.1
11.2
-53.5%
(5.3)
0.4
(0.9)
1.0
(0.0)
(1.4)
(1.3)
(2.4)
(0.3)
(0.3)
1.9
-83.0%
FCF
Y/Y FCF Growth
Y/Y Capex Growth
3.4
-79.2%
3.2%
(1.2)
-134.6%
-60.2%
7.6
-743.8%
42.9%
7.2
-5.2%
10.2%
(5.0)
2.2
0.3
(7.7)
(0.0)
(22.6)
10.8
(3.1)
(0.0)
(1.3)
(11.5)
(9.8)
(24.8)
(4.4)
(4.4)
(4.9)
(4.5)
-
-
0.5
0.1
0.6
8.3
34.6
42.9
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments
Sales of short-term investments
Change in restricted cash
Purchases of property and equipment
Purchases of intangible assets
Acquisition of the Loan Page, net of cash acquired
Acquisitions, net of cash acquired
Net cash provided by (used in) investing activities
0.2
1.4
(1.1)
1.5
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance costs related to the sale of common stock
Repayment of note payable
Cash held for third party common stock transaction
Cash paid to third party common stock transaction
Net proceeds from issuance of redeemable convertible preferred stock,
Series B
Purchase and retirement of common stock
Proceeds from exercises of stock options and warrants
Tax benefit from exercise of stock options
Proceeds from repayment of note receivable from officer/stockholder
Convertible preferred stock dividend
Common stock dividend
Deferred initial public offering costs
Proceeds from IPO
Net cash provided by (used in) financing activities
1.4
0.8
(9.5)
(0.1)
0.5
0.1
0.6
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
(9.9)
59.2
49.4
(23.0)
49.4
26.4
8.2
26.4
34.6
Source: Company reports and JPMorgan estimates.
176
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
InfoSpace, Neutral ($18.96)
As a second-tier player in the online search business, we believe InfoSpace will
continue to lose market share to the larger players. As such, we believe there is
little opportunity to accelerate its anemic growth, and thus maintain our Neutral
rating.
• Sale of directory and mobile businesses allows INSP to capture value
NOLs. With declining earnings, InfoSpace turned to selling its online
directory, for $225M, and mobile services businesses, for $135M, in
order to capture the value of $380M in NOLs the company was carrying.
As a result of the sales, INSP plans to return $300M, or $9 per share, to
shareholders in the form of a special dividend in Jan. ’08.
• Search Share Dwindling. According to our estimates, InfoSpace will see
its query volumes decline in 2007, as larger players continue to gain
market share. We now believe InfoSpace controls less than 0.5% of the
US search market, down from 1.4% just three years ago. Slowing RPS
growth has also had a negative impact on earnings, and we do not expect
a material improvement in 2008.
• 2008 Drivers. In our view, the following factors will drive the stock in
2008: (1) search market share declines, (2) the return of cash to
shareholders from the divesture of the mobile business in January 2008,
and (3) improving EBITDA margins as a result of the divesture of the
mobile businesses.
• Maintaining 4Q’07 Estimates. We are maintaining our 4Q revenue,
EBITDA and EPS estimates of $34.3M, $0.9M and ($0.24), respectively
However, we believe there is the potential for some additional upside to
margins following the divesture of its lower-margin mobile business.
Our current and newly introduced 2009 estimates are in the table below.
Table 108: InfoSpace Estimate Highlights
$ in millions
InfoSpace
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07
F'07
F'08
F'09
F'07 Y/Y
F'08 Y/Y
F'09 Y/Y
34.3
0.9
(0.24)
240.2
(9.4)
(1.49)
138.9
(15.5)
(0.88)
140.6
18.1
0.11
-35.4%
NM
NM
-42.2%
NM
NM
1.3%
NM
NM
34.5
1.7
0.17
240.4
NA
(1.44)
137.8
17.7
(0.27)
143.9
21.2
(0.58)
-35.3%
NM
NM
-42.7%
NM
NM
4.4%
NM
NM
Source: Company reports, FactSet and JPMorgan estimates.
Our Estimates and Outlook for 2008
In order to account for the $300M special dividend, we are adjusting our F’08
revenue, EBITDA and EPS estimates to $138.9M, ($15.5M), and ($0.88), from
$138.9M, $16.6M and $0.07, respectively.
177
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
In search, we believe InfoSpace will continue to lose search market share due to
its lack of brand awareness. In addition, we believe the company’s RPS will
remain flat in F’08. As a result, we are modeling Search & Directory revenues
of $138.9M, down 9.2% Y/Y.
During 2H'07, InfoSpace announced the sale of its mobile operations. Given that
the company no longer plans to support large investments in mobile-media
content, we believe that margin expansion is likely in 2008.
Our Estimates and Outlook for 2009
We are introducing our 2009 revenue, EBITDA and EPS estimates of $141M,
$18M and $0.11, respectively, suggesting Y/Y growth (excluding the impact of
the 1x special dividend) of 1%, 9%and 57%, respectively.
In 2009, we expect InfoSpace to continue to face difficulties growing its search
business as it continues to lose market share. As such, we are modeling Search
& Directory revenues to grow 1% in 2009 to $140.6M. However, we expect
margins to continue to improve from the divesture of lower-margin mobile
businesses. As such, we are modeling F’09 EBITDA margins of 12.9%, up from
11.9% in F’08 (excluding the impact of the special dividend).
Valuation and Rating Analysis
On an EV/EBITDA basis, INSP trades at 3.2x our calendar F’08 pro forma
EBITDA estimate of $16.6M, compared with its peers, which trade at an
average of 12.1x F’08E EV/EBITDA. Although many investors may find the
valuation compelling, we believe the stock will trade in line unless the company
demonstrates improving fundamentals. Consequently, we maintain our Neutral
rating.
Risks to Our Rating
Among the risks to our rating are INSP’s dependence on the online advertising
industry, integration risks associated with recent acquisitions, and competition
from larger portal players. Additionally, if the company is unable to renew any
of its search distribution partnerships, INSP’s Search and Directory revenue may
decline. We believe that most of the contracts with the distribution partners are
2-3 years in length. Finally, if Google, Yahoo! and InfoSpace are not able to
increase search RPMs, our estimates could prove to be too aggressive.
178
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 109: INSP Annual Income Statement
$ in millions, except per share data
FY
2006
FY
2007E
FY
2008E
FY
2009E
Online
Mobile
Revenues Ex Payment
186.9
184.8
371.7
152.9
87.3
240.2
138.9
138.9
140.6
140.6
Content and Distribution Costs
System and Network Operation
Product Development
Sales and Marketing
G&A
Depreciation
Amortization of Intangibles
Restructuring Charges
Impairment of other intangible
Expense related to Spec. Div.
Stock-based Comp (FAS 123R)
Total Expenses
178.3
29.6
43.7
41.7
43.9
16.1
12.2
62.3
16.9
444.7
102.0
21.3
39.7
23.0
41.5
17.2
3.8
(1.9)
21.8
39.5
286.0
58.0
12.0
19.0
12.6
20.7
8.0
0.4
32.1
16.0
178.8
57.4
12.2
19.2
12.7
21.0
8.0
0.4
16.0
146.9
Operating Profit (Reported)
Operating Profit (Pro forma)
Operating Margins (Reported)
Operating Margins (Pro Forma)
(73.0)
18.4
-19.6%
4.9%
(67.7)
(4.4)
-28.2%
-1.8%
(39.9)
8.6
-28.8%
6.2%
(6.3)
10.1
-4.5%
7.2%
EBITDA
EBITDA %
(27.8)
-7.5%
(9.4)
-3.9%
(15.5)
-11.2%
18.1
12.9%
Gain on Investments
Other, Net
Income Before Taxes
19.4
(53.6)
15.3
(52.4)
10.3
(29.6)
Income Taxes
Income From Disc. Ops
Income After Taxes
Accounting Change
EPS (GAAP)
(40.9)
(12.7)
(0.4)
3.1
(52.0)
(29.6)
10.3
4.0
4.0
(0.46)
(1.49)
(0.88)
0.11
Shares Outstanding
32.6
32.7
34.1
35.3
48.0%
8.0%
11.7%
11.2%
11.8%
42.5%
8.9%
16.5%
9.6%
17.3%
41.8%
8.7%
13.7%
9.0%
14.9%
40.8%
8.7%
13.7%
9.0%
14.9%
% Of Revenue
Content and Distribution Costs
System and Network Operation
Product Development
Sales and Marketing
G&A
Source: Company reports and JPMorgan estimates.
179
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 110: INSP Quarterly Income Statement
$ in millions, except per share data
1Q'06
2Q'06
Online
Mobile
Revenues Ex Payment
46.1
44.1
90.3
Content and Distribution Costs
System and Network Operation
Product Development
Sales and Marketing
G&A
Depreciation
Amortization of Intangibles
Restructuring Charges
Impairment of other intangible
Expense related to Spec. Div.
Stock-based Comp (FAS 123R)
Total Expenses
FY 2006
3Q'06
4Q'06
1Q'07
2Q'07
50.4
45.5
95.8
48.6
47.7
96.3
41.8
47.5
89.3
45.0
41.6
86.6
41.6
6.9
8.9
8.5
11.6
3.3
3.7
-
46.1
7.4
11.8
11.1
10.6
3.5
3.6
-
47.7
7.9
11.3
11.5
11.4
4.6
3.0
57.8
-
42.9
7.3
11.7
10.6
10.4
4.7
1.8
4.5
-
41.6
6.2
13.1
6.9
10.7
4.6
1.8
(0.8)
-
4.1
88.7
4.6
98.7
4.8
160.1
3.3
97.3
Operating Profit (Reported)
Operating Profit (Pro forma)
Operating Margins (Reported)
Operating Margins (Pro Forma)
1.6
9.4
1.7%
10.4%
(2.8)
5.4
-2.9%
5.7%
(63.8)
1.8
-66.3%
1.9%
EBITDA
EBITDA %
12.7
14.1%
8.9
9.3%
Gain on Investments
Other, Net
Income Before Taxes
3.9
5.4
Income Taxes
Income From Disc. Ops
Income After Taxes
Accounting Change
EPS (GAAP)
Shares Outstanding
Source: Company reports and JPMorgan estimates.
180
FY 2007
FY 2008E
2Q'08E
3Q'08E
3Q'07
4Q'07E
1Q'08E
4Q'08E
39.7
30.8
70.5
33.9
14.9
48.7
34.3
34.3
35.6
35.6
35.1
35.1
33.5
33.5
34.7
34.7
17.0
5.7
9.0
5.7
10.7
4.3
0.2
0.6
(0.4)
13.0
65.8
14.5
3.2
5.2
4.0
6.5
3.5
0.2
-
13.9
2.9
4.6
3.1
4.6
1.9
0.1
-
14.4
3.0
4.6
3.1
4.7
1.8
0.1
-
10.4
47.5
15.0
3.1
4.9
3.2
6.1
2.2
0.1
32.1
4.0
70.8
14.7
3.1
4.8
3.2
5.3
2.1
0.1
-
7.3
91.3
28.9
6.2
12.3
6.4
13.6
4.8
1.7
(1.7)
22.3
8.8
103.3
4.0
37.3
3.8
34.9
4.2
35.8
(8.0)
1.7
-8.9%
1.9%
(4.6)
3.6
-5.4%
4.2%
(32.8)
(1.7)
-46.5%
-2.4%
(17.0)
(3.7)
-35.0%
-7.6%
(13.2)
(2.6)
-38.4%
-7.5%
(35.2)
1.0
-99.1%
2.8%
(2.2)
1.9
-6.4%
5.3%
(1.4)
2.5
-4.2%
7.4%
(1.1)
3.2
-3.1%
9.3%
(51.3)
-53.3%
1.9
2.1%
9.0
10.4%
(17.5)
-24.8%
(1.8)
-3.7%
0.9
2.7%
(28.9)
-81.3%
4.0
11.3%
4.4
13.1%
5.0
14.5%
4.7
1.9
5.4
(58.4)
5.4
(2.6)
5.2
0.5
4.4
(28.4)
2.7
(14.3)
3.0
(10.2)
2.5
(32.7)
2.6
0.3
2.6
1.2
2.7
1.6
2.4
3.0
0.9
1.0
(11.7)
(46.7)
(32.6)
30.0
1.1
(0.5)
(0.3)
(28.1)
(0.7)
1.4
(12.3)
(0.5)
1.7
(8.0)
(32.7)
0.3
1.2
1.6
0.09
0.03
(1.49)
0.91
(0.02)
(0.86)
(0.37)
(0.24)
(0.97)
0.01
0.03
0.05
32.9
32.9
31.3
33.1
31.5
32.6
33.2
33.4
33.7
34.0
34.3
34.6
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 111: INSP Annual Balance Sheet
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
ASSETS
Cash/Equivalents
ST Investments
Accounts Rcvbl.,Net
Payroll Tax Rcvbl
Notes and other Rcvbl
Prepayments
Other
Total Current Assets
163.5
238.4
78.7
3.4
14.8
498.8
474.3
101.1
24.0
10.2
609.7
158.1
101.1
24.3
5.0
10.2
298.7
175.5
101.1
24.6
5.0
10.2
316.5
Prop./Equip., Net
LT Investments
Other Investments
Goodwill
Goodwill/Intang.
Deferred tax asset, net
Other LT Assets
Total Assets
33.2
104.4
19.6
101.6
8.2
765.8
33.5
44.2
8.9
696.3
33.5
44.2
8.9
385.3
33.5
44.2
8.9
403.1
13.0
61.2
6.7
4.1
20.6
8.8
80.9
33.5
4.2
20.8
8.8
33.8
4.2
21.1
8.8
34.2
LIABILITIES
Accounts Payable
Accrued Expenses
Deferred Revenue
Other Current Liabs.
Total Current Liabs
Other LT Liabs.
Deferred Taxes
Total Liabilities
SHAREHOLDER EQUITY
Total Equity
0.9
5.5
87.3
0.7
34.2
0.7
34.5
0.7
34.8
678.6
662.0
350.8
368.2
Total Liabilities & Equity
765.8
696.3
385.3
403.1
Source: Company reports and JPMorgan estimates.
181
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 112: INSP Annual Statement of Cash Flows
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
OPERATING CF's
Net Income
D&A
Impair. of Intang.
Warrant Income
Income from discontinued ops
Warrants Expense
Stock-based Compen.
Option Tax Benefits
Bad Debt Expense
Gain on Investments
Other Charges
Minority Interest
Non-Cash Items
Deferred Taxes
Changes in Working Capital
Amort. Trademark
Write-off R&D
Cash From Operations
(12.7)
28.3
16.9
0.2
62.3
(41.3)
(10.2)
43.5
(48.9)
19.8
(6.2)
38.5
(3.1)
1.6
0.4
13.2
15.2
(29.6)
8.4
16.0
(5.2)
4.0
8.4
16.0
28.4
FCF
20.9
(10.7)
(16.2)
17.4
(22.6)
0.0
(15.6)
(0.3)
(38.5)
(26.0)
3.0
360.0
135.4
472.4
(11.0)
(11.0)
(11.0)
(11.0)
1.8
3.6
5.4
1.4
12.9
(208.2)
(193.9)
(300.0)
(300.0)
-
-
17.3
(0.3)
17.1
-
-
Foreign Exch/Other Adj
Net Change In Cash
10.5
310.8
(316.2)
17.4
Beginning Cash
Ending Cash
153.0
163.5
163.5
474.3
474.3
158.1
158.1
175.5
INVESTING CF's
Capital Expenditures
Business Acquisition
Increase in other long-term assets
Asset Sale Proceeds
Proceeds from sale of disc. Ops
Other Investing
Purchase Intangible
Cash From Investing
FINANCING CF's
Proceeds from IPO
Issuance of Common
Stock to Employees
Exercise of Options
Debt, Net
Purch./Sale of Stock
Other Financing
Repayment of Notes
Cash From Financing
Discontinued Operations
Net cash provided by disc. Ops
Net cash used by disc. Ops
Net cash provided
Source: Company reports and JPMorgan estimates.
182
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
InnerWorkings, Neutral ($18.40)
InnerWorkings has continued to post rapid revenue growth in F’07, with both
acquisitions and organic growth accounting for the rise. We think the speed with
which the company can achieve its long-run profitability profile remains the key
unknown going forward.
•
Several major acquisitions in F’07. InnerWorkings made five notable
acquisitions in F’07, with the most significant being the acquisition of NYbased Corporate Edge in 4Q; Corporate Edge had revenue of approximately
$60M in F’06. The price was ~$33M in cash, with $18M due immediately
and $15M available as earnouts over three years. At its 4Q investor day,
InnerWorkings noted that all previous acquisition earnouts have been
achieved, and the company has ~$25M in earnouts outstanding going
forward.
•
Revenue growth to remain strong. At just above the midpoint of F’08
guidance, we are projecting 64% revenue growth in F’08, and just over 40%
revenue growth excluding the impact of the Corporate Edge acquisition.
•
Speed of profitability improvements will be key catalyst. The first three
quarters of F’07 saw nearly 400 bps in Y/Y gross margin improvement,
while operating margins over the same period were flat Y/Y. We believe the
speed with which InnerWorkings is able to ramp profitability and cash flow
generation remains the key area of focus: since F’04, the company has
generated $475M in revenue, but less than $1M in operating cash flows and
negative free cash flow.
•
2008 Drivers. In our view, the following factors will drive the stock in
2008: (1) Profitability and cash flow generation; (2) integration of acquired
companies; (3) pace of revenue growth.
•
Raising 4Q’07 and F’07 estimates. In view of the Corporate Edge
acquisition, we are raising our revenue, EBITDA and EPS estimates to
$89.7M, $9.3M and $0.11, respectively, from $84.6M, $8.8M and $0.10.
We are raising our F’07 estimates to $288M, $26.8M and $0.32,
respectively, from $283M, $26.3M and $0.31.
Table 113: InnerWorkings Consensus Snapshot
$ in millions, except per-share data
INWK
JPM
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E
Y/Y
F'08E
F'09E
90
9
$0.11
288
27
$0.32
472
46
$0.52
641
65
$0.73
78.9%
91.5%
52.5%
63.8%
70.7%
63.3%
35.9%
42.3%
39.4%
87
9
0.11
286
26
0.32
467
45
0.51
625
61
0.72
77.7%
84.8%
54.0%
63.4%
72.4%
59.1%
33.8%
36.6%
39.5%
Source: Company reports, FactSet, JPMorgan estimates.
183
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
Taking into account the Corporate Edge acquisition, we now project InnerWorkings
to achieve F’08 revenue of $472M, just above the midpoint of company guidance.
We note that any further significant acquisitions may push F’08 revenue higher. We
now expect F’08 EBITDA of $45.8M, and EPS of $0.52.
The company has stated it expects to grow operating margins ~50-60 bps per year,
and our F’08 projections imply a Y/Y 55 bps improvement in operating margin Y/Y.
Previously, we had modeled revenue, EBITDA and EPS of $414M, $40.9M and
$0.50, respectively.
Our Estimates and Outlook for 2009
We think the company can draw a slightly higher percentage of business from
Enterprise clients in F’09, at 64.3%, up from 61.6% in F’08. We are modeling 36%
Y/Y revenue growth, to $641M, and projecting ~50 bps operating margin expansion,
leading to $65.1M in EBITDA and EPS of $0.73.
Valuation and Rating Analysis
INWK is trading at a 18.6x EV/EBITDA multiple based on our F’08 estimate, a
premium to the peer group avg. of 19.1x. While INWK is growing revenue at a faster
rate than peers, we believe that multiple expansion is unlikely. As a result, we are
maintaining our Neutral rating.
Risks to Our Rating
The company may outperform our expectations if it is able to grow its sales force
organically or through acquisitions faster than expected, if operational leverage is
higher than modeled, or if it is able to negotiate better gross margins with its clients.
The company may underperform our expectations as revenue generation is currently
concentrated among a few key clients. Additionally, concentration among a group of
key suppliers means that a loss of any of these printers from the supplier network
could have a significant impact on the depth of printing orders offered, the ability to
fulfill orders, the cost savings obtained, and margins. Finally, margin expansion,
sales force growth, and client penetration may be slower than expected if competition
increases, skilled salesman are difficult to obtain and train, or no viable acquisitions
are available.
184
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 114: INWK Annual Income Statement
$ in millions, except per share data
FY
2006
160.5
124.0
36.5
22.8%
248
FY
2007E
288.1
214.9
73.2
25.4%
264
FY
2008E
471.8
350.8
121.0
25.6%
24
FY
2009E
641.0
475.5
165.5
25.8%
17
8.8
13.3
0.6
1.0
23.7
17.9
28.5
1.0
2.3
49.7
30.0
45.3
1.4
3.3
79.9
40.1
60.3
2.1
4.3
106.7
Income from operations
Operating Margin
Y/Y Improvement (bps)
EBITDA
12.8
8.0%
201
14.4
23.5
8.2%
16
26.8
41.1
8.7%
55
45.8
58.8
9.2%
47
65.1
Other income
Interest income
Interest expense
Minority interest
Other, net
Total other income
0.9
(0.1)
(0.0)
0.8
2.5
(0.0)
0.4
2.9
2.0
(0.0)
0.6
2.6
2.4
(0.0)
0.6
3.0
13.6
(5.3)
39.2%
26.4
(10.3)
39.1%
43.6
(17.0)
38.9%
61.8
(24.0)
38.9%
8.3
8.3
8.3
16.0
16.0
16.0
26.6
26.6
26.6
37.7
37.7
37.7
$0.20
$0.20
39.5
$0.32
$0.32
50.0
$0.52
$0.52
50.9
$0.73
$0.73
51.7
108.8%
184.2%
178.9%
221.4%
79.5%
85.8%
83.0%
59.2%
63.8%
70.7%
74.8%
63.3%
35.9%
42.3%
43.2%
39.4%
77.2%
5.5%
8.3%
0.3%
74.6%
6.2%
9.9%
0.4%
74.4%
6.4%
9.6%
0.3%
74.2%
6.3%
9.4%
0.3%
Revenue
Cost of goods sold
Gross profit
Gross margin
Y/Y Improvement (bps)
Operating Expenses
Commission expense
General and Administrative Expense
Stock-based compensation
Depreciation and amortization
Total operating expenses
Income before taxes
Income tax expense
Tax Rate
Net income
Dividends on preferred shares
Net income applicable to common shareholders
Pro Forma Net Income
Diluted EPS
Pro Forma Diluted EPS
Shares outstanding
% Y/Y growth
Revenue
EBITDA
Operating income
EPS
% of Revenue
COGS
Commission expense
General and Administrative
Stock Based compensation
Source: Company reports and JPMorgan estimates.
185
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 115: INWK Quarterly Income Statement
$ in millions, except per share data
1Q07
58.9
44.5
14.4
24.4%
433
1.7
2.3
0.1
0.2
4.3
2.3
3.2
0.2
0.2
5.9
3.9
5.8
0.3
0.5
10.4
3.9
6.0
0.3
0.4
10.6
4.2
6.7
0.2
0.5
11.6
1.4
6.1%
161
1.5
2.8
7.9%
180
3.1
3.6
8.7%
191
4.1
5.1
8.3%
239
5.8
3.8
6.4%
34
4.5
0.1
(0.1)
(0.0)
0.0
0.1
(0.0)
0.0
0.0
0.3
(0.1)
(0.0)
0.2
0.4
(0.0)
0.4
1.4
(0.6)
41.4%
2.8
(1.1)
39.2%
3.9
(1.5)
39.1%
0.8
0.8
0.8
1.7
1.7
1.7
Diluted EPS
Pro Forma Diluted EPS
Shares outstanding
$0.02
$0.02
33.1
% Q/Q growth
Revenue
EBITDA
Operating income
0.9%
5.2%
4.6%
Other income
Interest income
Interest expense
Minority interest
Other, net
Total other income
Income before taxes
Income tax expense
Tax Rate
Net income
Dividends on preferred shares
Net income applicable to common shareholders
Pro Forma Net Income
186
0.9
2.1
0.1
3.1
FY07E
2Q07
3Q07
67.3
72.1
50.1
53.8
17.2
18.3
25.6%
25.4%
546
258
4Q06
61.2
45.7
15.4
25.2%
573
Income from operations
Operating Margin
Y/Y Improvement (bps)
EBITDA
2Q06
35.1
28.1
7.1
20.1%
(94)
FY06
3Q06
41.8
32.2
9.5
22.8%
240
Revenue
Cost of goods sold
Gross profit
Gross margin
Y/Y Improvement (bps)
Operating Expenses
Commission expense
General and Administrative Expense
Stock-based compensation
Depreciation and amortization
Total operating expenses
1Q06
22.4
17.9
4.5
20.1%
(16)
FY08E
2Q08E
3Q08E
110.2
119.7
82.2
89.1
28.0
30.7
25.4%
25.6%
(16)
18
4Q07E
89.7
66.5
23.2
25.9%
68
1Q08E
95.8
71.3
24.4
25.5%
108
4Q08E
146.1
108.2
37.9
25.9%
3
4.0
7.6
0.2
0.6
12.5
5.8
8.2
0.3
0.7
14.9
6.2
9.5
0.3
0.8
16.7
6.9
10.5
0.3
0.8
18.5
7.5
11.7
0.4
0.8
20.4
9.5
13.6
0.4
0.9
24.4
5.6
8.3%
37
6.3
5.8
8.1%
(64)
6.7
8.3
9.3%
100
9.3
7.7
8.1%
166
8.8
9.6
8.7%
37
10.7
10.3
8.6%
51
11.5
13.5
9.2%
(2)
14.8
0.6
(0.0)
0.6
0.6
(0.0)
0.1
0.7
0.6
(0.0)
0.1
0.8
0.7
(0.0)
0.1
0.8
0.5
(0.0)
0.1
0.6
0.5
(0.0)
0.1
0.6
0.5
(0.0)
0.1
0.6
0.5
(0.0)
0.1
0.6
5.5
(2.1)
38.6%
4.3
(1.7)
38.6%
6.3
(2.5)
39.1%
6.6
(2.6)
39.0%
9.1
(3.6)
39.5%
8.4
(3.2)
38.6%
10.2
(4.0)
39.0%
10.9
(4.3)
39.0%
14.1
(5.5)
39.0%
2.4
2.4
2.4
3.4
3.4
3.4
2.7
2.7
2.7
3.8
3.8
3.8
4.0
4.0
4.0
5.5
5.5
5.5
5.1
5.1
5.1
6.2
6.2
6.2
6.7
6.7
6.7
8.6
8.6
8.6
$0.05
$0.05
33.1
$0.05
$0.05
43.6
$0.07
$0.07
48.1
$0.05
$0.05
49.3
$0.08
$0.08
50.1
$0.08
$0.08
50.2
$0.11
$0.11
50.4
$0.10
$0.10
50.6
$0.12
$0.12
50.8
$0.13
$0.13
51.0
$0.17
$0.17
51.2
56.6%
104.1%
104.0%
18.9%
32.2%
30.7%
46.4%
41.2%
38.8%
-3.6%
-22.0%
-25.1%
14.2%
40.8%
47.6%
7.2%
6.1%
4.3%
24.3%
38.1%
42.5%
6.8%
-5.2%
-6.7%
15.0%
21.5%
23.4%
8.7%
7.4%
7.6%
22.0%
29.1%
31.4%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
EPS
% Y/Y growth
Revenue
EBITDA
Operating income
EPS
% of Revenue
COGS
Commission expense
General and Administrative
Stock Based compensation
80.6%
127.4%
145.9%
87.5%
141.7%
142.5%
78.1%
139.8%
128.2%
174.9%
300.6%
287.2%
162.7%
197.3%
177.2%
91.5%
105.1%
100.5%
72.7%
64.7%
60.0%
46.6%
61.1%
64.3%
62.5%
95.7%
104.6%
63.7%
68.8%
71.0%
66.0%
70.8%
76.3%
62.9%
59.7%
62.6%
79.9%
4.0%
9.3%
0.0%
79.9%
4.9%
6.5%
0.3%
77.2%
5.5%
7.6%
0.5%
74.8%
6.4%
9.4%
0.4%
75.6%
6.6%
10.2%
0.5%
74.4%
6.3%
9.9%
0.4%
74.6%
5.5%
10.6%
0.3%
74.1%
6.4%
9.1%
0.3%
74.5%
6.4%
9.9%
0.3%
74.6%
6.2%
9.5%
0.3%
74.4%
6.2%
9.8%
0.3%
74.1%
6.5%
9.3%
0.3%
Source: Company reports and JPMorgan estimates.
187
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 116: INWK Annual Balance Sheet
$ in millions
FY
2006
Assets
Current Assets:
Cash and cash equivalents
Marketable securities
Accounts receivable
Unbilled revenue
Inventories
Prepaid expenses
Advances to related parties
Deferred income taxes
Other current assets
Total current assets
Property and equipment, net
Intangibles and other assets:
Goodwill
Intangible assets
Deposits
Investment
Deferred income taxes
Other assets
Total intangibles and other assets
Total assets
Liabilities and stockholders' deficit/members equity
Current liabilities:
Accounts payable - trade
Advances from related parties
Due to seller
Distribution payable
Outstanding line of credit
Current maturities of capital lease obligations
Customer deposits
Other liabilities
Deferred revenue
Accrued expenses
Total current liabilities
Capital lease obligations, less current maturities
Mandatorily redeemable preferred stock - Class D
Total liabilities
Class C, Convertible redeemable preferred shares
Class D, Convertible redeemable preferred shares
Class E, Convertible redeemable preferred shares
Stockholders' deficit/member's equity:
Total stockholders' equity
Total liabilities and stockholders' deficit/members' equity
Source: Company reports and JPMorgan estimates.
188
FY
2007E
20.6
10.0
45.0
4.7
2.1
5.5
0.1
0.3
1.3
89.5
2.8
9.7
6.5
0.2
0.1
4.5
0.0
21.2
113.5
24.0
0.2
1.6
0.1
1.9
0.8
0.2
3.0
31.8
0.2
32.1
81.5
113.5
FY
2008E
FY
2009E
26.2
16.0
69.7
9.8
35.6
16.0
113.5
9.8
61.4
16.0
148.3
9.8
4.3
0.1
0.8
2.0
128.8
3.6
15.6
8.0
0.2
0.1
4.1
0.0
28.1
160.5
38.2
0.6
0.1
2.3
1.2
3.5
45.9
0.2
0.0
46.1
114.4
160.5
4.3
0.1
0.8
2.0
182.0
3.6
15.6
8.0
0.2
0.1
4.1
0.0
28.1
213.7
62.2
0.6
0.1
2.3
1.2
3.5
70.0
0.2
0.0
70.1
143.6
213.7
4.3
0.1
0.8
2.0
242.6
3.6
15.6
8.0
0.2
0.1
4.1
0.0
28.1
274.3
81.0
0.6
0.1
2.3
1.2
3.5
88.8
0.2
0.0
88.9
185.3
274.3
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 117: INWK Annual Cash Flow Statement
$ in millions
Cash flows from operating activities
Net income
Adjustments to reconcile NI to Net Cash by operating activities:
Minority interest
Deferred income taxes
Noncash stock compensation expense
Depreciation and amortization
Bad debt provision
Deferred financing expense
Advances to related parties
Change in assets:
Accounts receivable
Unbilled revenue
Inventory
Prepaid expenses and other
Change in liabilities:
Accounts payable
Customer deposits
Taxes payable
Accrued expenses and other
Net cash provided by operating activities
Cash flows from investing activities
Purchases of property and equipment
Sale/(Purchase) of marketable securities
Investment in Echo
Purchase of customer list
Purchase of Ocular
Purchase of Graphography
Other purchases
Purchase of AppliedGraphics
Net cash used in investing activities
Cash flows from financing activities
Net repayments of note payable, bank
Repayment of memer receivable
Payment of deferred financing fees
Principal payments on capital lease obligations
Tax benefit of stock options exercised
Payments of distributions
Payment of dividends on preferred shares
Preference payments on preferred shares
Issuance of shares
Payment of issuance costs
Payments for share repurchase
Net cash provided by financing activities
Increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
FCF
FY
2006
FY
2007E
FY
2008E
FY
2009E
8.3
16.0
26.6
37.7
0.9
0.6
1.0
0.3
0.0
0.2
(0.2)
1.0
2.3
0.3
0.0
(0.1)
(0.5)
1.4
3.3
0.3
0.0
-
(0.5)
2.1
4.3
0.3
0.0
-
(21.7)
(1.2)
(21.2)
(4.1)
(43.8)
-
(34.8)
-
(1.2)
4.5
(2.9)
0.4
1.5
(9.7)
0.8
10.5
0.2
(2.0)
2.8
24.0
11.3
18.8
27.8
(1.4)
(10.0)
(3.3)
(0.3)
(7.2)
(22.1)
(1.8)
(5.9)
(1.2)
(30.2)
(1.8)
-
(2.0)
-
(39.0)
(1.8)
(2.0)
(7.0)
-
-
-
(0.1)
0.4
(3.3)
(1.6)
(5.5)
109.1
(2.6)
(40.0)
49.5
17.7
(0.1)
4.2
37.7
41.8
5.6
(0.1)
(0.1)
9.4
(0.1)
(0.1)
25.8
3.0
20.6
20.6
26.2
26.2
35.6
35.6
61.4
(11.1)
1.0
9.5
25.8
Source: Company reports and JPMorgan estimates.
189
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Liberty Interactive, Neutral ($19.79)
We are maintaining our Neutral rating on the Liberty Interactive tracking stock
because we believe that the company will face challenging growth in F’08 as the
domestic arm of QVC faces a difficult retail environment in a tightening economy
and as turnaround efforts at QVC Germany may last longer. Additionally, we note
that QVC Japan will not completely comp health and beauty declines until 4Q'08.
• Domestic QVC growth slowing amongst increased competition and a
tightening economy. We are modeling F’08 Y/Y growth of 3% following
F'07E's growth of 4%. We are concerned with recent domestic performance
weakness due to slowing consumer spending and see this continuing as the
consumer weathers the sub-prime lending fallout. We also believe that
competition for nationally branded merchandise has become stiffer with HSN’s
re-merchandising strategy and that this may further pressure margins.
• We believe int’l expansion efforts will be put on hold until current problems
are addressed. At the beginning of 2007, the int'l markets could not have looked
brighter with QVC Japan revenues growing 20% Y/Y in F'06, total int'l revenue
growth of 12%, and the company positioning itself for entry into the China
market. However, this year we expect F’08 int'l revenue growth of only 1% as
the company struggles to perfect its merchandising strategy in Germany and as
Japan health and beauty sales (~21% of business a year ago) plummet due to
increased regulatory scrutiny. We now think that the company will put further
expansion efforts on hold until these weaknesses are addressed.
• QVC margin pressure likely. We expect int’l margins to continue to be
pressured as investments are made to drive the Germany and Japan turnarounds.
Furthermore, we believe domestic margins might be pressured due to possible
inventory buildup in the slowing sales economy and pricing pressure from
increased HSN competition. As such, we are modeling F’08 QVC operating cash
flow margins as remaining roughly flat with F’07E's depressed levels.
• 2008 Drivers. In our view, the following factors will drive LINTA shares in
2008: (1) clearance of old inventory in Germany, (2) comping Japan health and
beauty losses, and (3) improved US economic conditions.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $2.40B, $569M, and $0.32 (Y/Y growth of 3.8%, 0.7%, and
(26%) respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 118: Liberty Interactive Financial Snapshot
$ in millions, except per share data
Liberty Interactive
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
2,398.82
569.09
0.32
7,720.82
1,707.09
0.74
8,094.31
1,765.73
0.80
8,583.14
1,871.07
0.89
5.39%
1.61%
0.91%
4.84%
3.43%
8.57%
6.04%
5.97%
11.52%
2,417.00
575.00
0.30
7,734.00
1,667.00
0.72
8,156.00
1,775.00
0.79
8,727.00
1,952.00
1.02
5.46%
6.48%
9.72%
7.00%
9.97%
29.11%
Source: JPMorgan estimates, Company data, and Factset
190
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We are maintaining our F’08 revenue estimate of $8.09B and our full year EBITDA
estimate of $1.77B, representing Y/Y revenue and EBITDA growth of 5% and 3%,
respectively.
Domestically, we believe that the tightening economic conditions we currently see
will persist into F’08. JPMorgan’s most recent US economic outlook calls for only
an average real GDP growth (SAAR) of 2% in 1H’08. As a result of this, we see
consumer discretionary spending tightening up. During the 3Q conference call,
Liberty Media management noted that domestic QVC sales grew only 2% Y/Y vs.
6% growth in 1H'07 due to a difficult retail environment.
Table 119: JPMorgan US Economic Outlook
percent
Economic Outlook
Real GDP
IP
CPI
PPI
%ch saar
%oya
%ch saar
%oya
%ch saar
%oya
%oya
07Q2
3.8
1.9
4.3
1.9
6.0
2.7
3.4
07Q3
4.9
2.8
4.1
1.9
1.9
2.4
3.5
07Q4
0.5
2.4
1.5
2.7
4.1
3.9
5.0
08Q1
1.5
2.7
2.0
3.0
3.2
3.8
3.8
08Q2
2.5
2.3
3.0
2.7
1.6
2.7
1.8
08Q3
3.5
2.0
4.0
2.6
1.9
2.7
1.9
08Q4
3.0
2.6
3.0
3.0
2.4
2.3
1.6
Source: JPMorgan economic analysis
We also see domestic growth pressured by increased competition from HSN. With
HSN’s new management team in place and inventory levels more under control, we
believe that their focus has shifted to better merchandising and growing nationally
branded product offerings. This could lead to increased competition between HSN
and QVC for the same brands and could pressure margins. As a result, we are now
modeling F’08 Y/Y growth of 3% following F'07E's growth of 4%.
International weakness is expected to persist into F’08. In F’07, QVC Germany sales
were hurt by efforts to reduce reliance on a small number of core brands that had
been over rotated, and ASPs and margins were impacted by markdowns needed to
clear underperforming inventory. QVC Japan saw sales growth plummet in F’07 as
health and beauty regulatory changes had the health product category fall from 21%
of the business a year ago to less than 9% this year. Offsetting this, other product
categories are experiencing growth in the 20-40% range. However, we now believe
that the impact of regulatory changes will not be comped until 4Q’08. As we believe
regulatory and operational problems will persist longer than expected, we are now
modeling QVC international revenue growth of only 1.3% in F’08.
Our Estimates and Outlook for 2009
We are introducing F’09 revenue, EBITDA, and EPS estimates of $8.58B, $1.87B,
and $0.89, which represents Y/Y growth of 6%, 6%, and 12%, respectively. We
believe that much of the revenue growth will be driven by international markets
where Germany and Japan will see easing comps given their expected weakness in
F’08. We believe that QVC Japan will continue to post strong growth as product
lines outside of health and beauty have not shown any weakness.
191
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Valuation and Rating Analysis
LINTA is trading at a 10x EV/EBITDA multiple on our F’08 EBITDA estimate of
$1.77B, which is a discount to the peer group average of 19x EBITDA in F’08E.
Given that we expect F’08 EBITDA growth of only 3% vs. the peer group average of
36%, we believe that this discount is justified and that the stock will trade in line
with its peers.
Risks to Our Rating
QVC could outperform our estimates if German operational difficulties are turned
around faster than expected, the Japan regulatory environment shifts, or domestic
economic conditions recover. Outperformance might also occur if strategic
acquisitions are made in the e-commerce space.
QVC growth could slow if increased competition from HSN and Shop NBC
decreases domestic market share, weakness in jewelry persists, or if increased
programming costs hinder margin growth. Furthermore, QVC Japan could encounter
additional difficulties if more product lines come under regulatory scrutiny.
192
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 120: LINTA Annual Income Statement
$ in millions, except per share data
FY-06
FY-07E
FY-08E
FY-09E
Net Sales
QVC
Other
Total Sales
7,074.00
252.00
7,326.00
7,351.41
369.41
7,720.82
7,540.19
554.12
8,094.31
7,862.79
720.35
8,583.14
Cost of Sales
QVC
Other
Total Cost of Sales
4,426.04
138.96
4,565.00
4,635.34
224.33
4,859.67
4,753.04
365.72
5,118.75
4,960.99
482.64
5,443.63
Gross Profit
Gross Margin
2,761.00
37.7%
2,861.14
37.1%
2,975.55
36.8%
3,139.51
36.6%
Operating Costs
Operating Expenses
SG&A Expenses
Stock Based Compensation
Depreciation and Amortization
Total Operating Cost & Expenses
Total Operating Expenses (less Cost of Sales)
596.00
485.00
59.00
491.00
6,196.00
1,631.00
624.71
529.34
52.99
534.27
6,600.98
1,741.31
654.78
555.05
73.58
549.10
6,951.26
1,832.50
687.71
580.73
78.01
572.58
7,362.66
1,919.03
1,656.00
24.00
1,680.00
22.9%
3.23
1,675.25
31.85
1,707.09
22.1%
3.72
1,730.23
35.50
1,765.73
21.8%
3.62
1,794.55
76.52
1,871.07
21.8%
3.02
1,130.00
0.00
1,130.00
15.4%
1,112.10
7.74
1,119.84
14.5%
1,105.73
37.32
1,143.05
14.1%
1,143.34
77.15
1,220.49
14.2%
Other Income :
Interest Expense
Dividend and interest income
Share of earnings of affiliates
Realized and Unrealized gains on derivative instruments net
Gains losses on other instruments, net
Other,net
Total Other Income
(417.00)
40.00
47.00
20.00
0.00
23.00
(287.00)
(449.02)
46.00
80.00
2.00
12.00
12.00
(297.02)
(436.08)
49.00
55.00
8.00
0.00
16.00
(308.08)
(436.08)
52.00
55.00
8.00
0.00
16.00
(305.08)
Earnings from continuing operations before income tax and minority interests
Income Tax Expense
Tax Rate
Minority Interests in earnings of subsidiaries
Cumulative effect of accounting change, net of taxes
EBITDA
843.00
(210.00)
24.9%
(35.00)
0.00
1,680.00
822.82
(330.33)
40.1%
(26.00)
834.96
(333.99)
40.0%
(24.00)
915.40
(366.16)
40.0%
(24.00)
511.00
598.00
8.2%
1,707.09
0.22
466.49
466.49
6.0%
1,765.73
0.22
476.98
476.98
5.9%
1,871.07
0.22
525.24
525.24
6.1%
GAAP Earnings Per Share
Basic
Diluted
0.73
0.73
0.74
0.74
0.80
0.80
0.89
0.89
Pro Forma Earnings Per Share
Basic
Diluted
0.89
0.89
0.73
0.73
0.80
0.80
0.89
0.89
670.00
637.03
597.50
590.00
Operating Cash Flow
QVC
Other
Total Operating Cash Flow
Operating Margin
Leverage
Operating Income (Loss)
QVC
Other
Total Operating Income (Loss)
Operating Margin
GAAP Net Earnings
Pro Forma Net Earnings
Net Margin
Shares Outstanding
Basic
193
Imran Khan
(1-212) 622-6693
[email protected]
Diluted
As a % of Net Sales
Other Cost of Sales
Cost of Sales
Operating Expenses
SG&A Expenses
Y/Y Change
Net Sales
QVC Sales
Other Sales
Cost of Sales
SG&A Expenses
Depreciation and Amortization
Stock Based Compensation
Operating Cash Flow
Operating Income
Source: Company reports and JPMorgan estimates.
194
North America Equity Research
02 January 2008
FY-06
670.00
FY-07E
638.28
FY-08E
597.50
FY-09E
590.00
62.3%
8.1%
6.6%
62.9%
8.1%
6.9%
63.2%
8.1%
6.9%
63.4%
8.0%
6.8%
12.7%
8.8%
5.4%
3.9%
46.6%
6.5%
9.1%
8.8%
-10.2%
1.6%
-0.9%
4.8%
2.6%
50.0%
5.3%
4.9%
2.8%
38.9%
3.4%
2.1%
6.0%
4.3%
30.0%
6.3%
4.6%
4.3%
6.0%
6.0%
6.8%
11.0%
20.6%
844.2%
-86.9%
18.7%
23.4%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 121: LINTA Quarterly Income Statement
$ in millions, except per share data
31-Mar
Q1-06A
FY-2006
30-Jun
30-Sep
Q2-06A
Q3-06A
31-Dec
Q4-06
31-Mar
Q1-07
FY-2007E
30-Jun
30-Sep
Q2-07
Q3-07
31-Dec
Q4-07E
31-Mar
Q1-08E
FY-2008E
30-Jun
30-Sep
Q2-08E
Q3-08E
31-Dec
Q4-08E
Net Sales
QVC
Other
Total Sales
1,555.00
53.00
1,608.00
1,630.00
85.00
1,715.00
1,653.00
40.00
1,693.00
2,236.00
74.00
2,310.00
1,684.59
86.41
1,771.00
1,693.00
98.00
1,791.00
1,686.00
74.00
1,760.00
2,287.82
111.00
2,398.82
1,728.45
129.62
1,858.07
1,721.94
147.00
1,868.94
1,729.39
111.00
1,840.39
2,360.41
166.50
2,526.91
Cost of Sales
QVC
Other
Total Cost of Sales
971.71
28.29
1,000.00
1,006.68
47.32
1,054.00
1,040.39
22.61
1,063.00
1,407.27
40.73
1,448.00
1,060.57
49.43
1,110.00
1,056.94
55.06
1,112.00
1,068.41
46.59
1,115.00
1,449.41
73.26
1,522.67
1,089.77
85.55
1,175.31
1,076.51
97.02
1,173.53
1,095.91
73.26
1,169.17
1,490.84
109.89
1,600.73
608.00
37.8%
661.00
38.5%
630.00
37.2%
862.00
37.3%
661.00
37.3%
679.00
37.9%
645.00
36.6%
876.14
36.5%
682.76
36.7%
695.41
37.2%
671.21
36.5%
926.17
36.7%
132.00
111.00
27.00
120.00
1,390.00
390.00
141.00
135.00
17.00
125.00
1,472.00
418.00
142.00
123.00
-7.00
122.00
1,443.00
380.00
181.00
116.00
22.00
124.00
1,891.00
443.00
144.00
135.00
13.00
125.00
1,527.00
417.00
148.00
138.00
9.00
137.00
1,544.00
432.00
148.00
134.00
7.00
135.00
1,539.00
424.00
184.71
122.34
23.99
137.27
1,990.98
468.31
152.36
141.21
18.58
136.55
1,624.02
448.70
153.25
145.78
18.69
136.03
1,627.29
453.75
154.59
141.71
11.04
134.89
1,611.41
442.24
194.57
126.35
25.27
141.62
2,088.55
487.81
355.00
10.00
365.00
22.7%
378.00
7.00
385.00
22.4%
366.00
(1.00)
365.00
21.6%
557.00
8.00
565.00
24.5%
374.00
8.00
382.00
21.6%
383.00
10.00
393.00
21.9%
364.00
(1.00)
363.00
20.6%
554.25
14.85
569.09
23.7%
382.43
6.75
389.18
20.9%
389.98
6.40
396.38
21.2%
380.34
(5.43)
374.91
20.4%
577.48
27.77
605.26
24.0%
212.00
6.00
218.00
13.6%
242.00
1.00
243.00
14.2%
257.00
(7.00)
250.00
14.8%
419.00
0.00
419.00
18.1%
243.00
1.00
244.00
13.8%
244.00
3.00
247.00
13.8%
231.00
(10.00)
221.00
12.6%
394.10
13.74
407.84
17.0%
228.60
5.46
234.05
12.6%
236.72
4.93
241.66
12.9%
228.16
0.82
228.98
12.4%
412.25
26.11
438.36
17.3%
(93.00)
9.00
4.00
20.00
0.00
1.00
(59.00)
(97.00)
10.00
17.00
(3.00)
0.00
12.00
(61.00)
(108.00)
10.00
8.00
5.00
0.00
2.00
(83.00)
(119.00)
11.00
18.00
(2.00)
0.00
8.00
(84.00)
(114.00)
11.00
15.00
2.00
0.00
0.00
(86.00)
(105.00)
12.00
24.00
(4.00)
12.00
4.00
(57.00)
(121.00)
11.00
22.00
2.00
0.00
4.00
(82.00)
(109.02)
12.00
19.00
2.00
0.00
4.00
(72.02)
(109.02)
12.00
6.00
2.00
0.00
4.00
(85.02)
(109.02)
12.00
19.00
2.00
0.00
4.00
(72.02)
(109.02)
12.00
10.00
2.00
0.00
4.00
(81.02)
(109.02)
13.00
20.00
2.00
0.00
4.00
(70.02)
Gross Profit
Gross Margin
Operating Costs
Operating Expenses
SG&A Expenses
Stock Based Compensation
Depreciation and Amortization
Total Operating Cost & Expenses
Total Operating Expenses (less Cost of Sales)
Operating Cash Flow
QVC
Other
Total Operating Cash Flow
Operating Margin
Leverage
Operating Income (Loss)
QVC
Other
Total Operating Income (Loss)
Operating Margin
Other Income :
Interest Expense
Dividend and interest income
Share of earnings of affiliates
Realized and Unrealized gains on derivative instruments net
Gains losses on other instruments, net
Other,net
Total Other Income
195
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
31-Mar
Q1-06A
159.00
FY-2006
30-Jun
30-Sep
Q2-06A
Q3-06A
182.00
167.00
31-Dec
Q4-06
335.00
31-Mar
Q1-07
158.00
FY-2007E
30-Jun
30-Sep
Q2-07
Q3-07
190.00
139.00
31-Dec
Q4-07E
335.82
31-Mar
Q1-08E
149.03
FY-2008E
30-Jun
30-Sep
Q2-08E
Q3-08E
169.64
147.96
31-Dec
Q4-08E
368.34
(76.00)
47.8%
(8.00)
(46.00)
25.3%
(10.00)
(45.00)
26.9%
(8.00)
(43.00)
12.8%
(9.00)
(60.00)
38.0%
(7.00)
(81.00)
42.6%
(7.00)
(55.00)
39.6%
(6.00)
(134.33)
40.0%
(6.00)
(59.61)
40.0%
(6.00)
(67.85)
40.0%
(6.00)
(59.18)
40.0%
(6.00)
(147.34)
40.0%
(6.00)
365.00
385.00
365.00
565.00
382.00
393.00
363.00
569.09
389.18
396.38
374.91
605.26
(11.00)
75.00
4.7%
125.00
126.00
7.3%
114.00
114.00
6.7%
283.00
283.00
12.3%
91.00
91.00
5.1%
102.00
102.00
5.7%
78.00
78.00
4.4%
195.49
195.49
8.1%
83.42
83.42
4.5%
95.78
95.78
5.1%
82.77
82.77
4.5%
215.00
215.00
8.5%
GAAP Earnings Per Share
Basic
Diluted
0.00
0.00
0.13
0.13
0.17
0.17
0.43
0.43
0.14
0.14
0.16
0.16
0.12
0.12
0.32
0.32
0.14
0.14
0.16
0.16
0.14
0.14
0.36
0.36
Pro Forma Earnings Per Share
Basic
Diluted
0.11
0.11
0.18
0.18
0.17
0.17
0.43
0.43
0.14
0.14
0.16
0.16
0.12
0.12
0.32
0.32
0.14
0.14
0.16
0.16
0.14
0.14
0.36
0.36
703.000
703.000
687.30
687.30
671.00
671.00
660.00
660.00
652.10
652.10
648.00
652.00
628.00
629.00
620.00
620.00
610.00
610.00
600.00
600.00
590.00
590.00
590.00
590.00
53.4%
62.2%
8.2%
6.9%
55.7%
61.5%
8.2%
7.9%
56.5%
62.8%
8.4%
7.3%
55.0%
62.7%
7.8%
5.0%
57.2%
62.7%
8.1%
7.6%
56.2%
62.1%
8.3%
7.7%
63.0%
63.4%
8.4%
7.6%
66.0%
63.5%
7.7%
5.1%
66.0%
63.3%
8.2%
7.6%
66.0%
62.8%
8.2%
7.8%
66.0%
63.5%
8.4%
7.7%
66.0%
63.3%
7.7%
5.0%
9.8%
6.2%
16.0%
10.2%
14.8%
12.1%
10.9%
7.3%
9.4%
10.4%
823.1%
-75.9%
14.6%
9.6%
14.2%
34.3%
861.5%
-84.9%
18.6%
26.6%
12.9%
22.4%
838.5%
-106.2%
21.0%
40.5%
8.5%
15.4%
853.8%
-80.4%
19.9%
20.7%
10.1%
8.3%
63.0%
11.0%
21.6%
4.2%
-51.9%
4.7%
11.9%
4.4%
3.9%
15.3%
5.5%
2.2%
9.6%
-47.1%
2.1%
1.6%
4.0%
2.0%
85.0%
4.9%
8.9%
10.7%
-200.0%
-0.5%
-11.6%
3.8%
2.3%
50.0%
5.2%
5.5%
10.7%
9.0%
0.7%
-2.7%
4.9%
2.6%
50.0%
5.9%
4.6%
9.2%
42.9%
1.9%
-4.1%
4.4%
1.7%
50.0%
5.5%
5.6%
-0.7%
107.7%
0.9%
-2.2%
4.6%
2.6%
50.0%
4.9%
5.8%
-0.1%
57.7%
3.3%
3.6%
5.3%
3.2%
50.0%
5.1%
3.3%
3.2%
5.3%
6.4%
7.5%
Earnings from continuing operations before income tax and
minority interests
Income Tax Expense
Tax Rate
Minority Interests in earnings of subsidiaries
Cumulative effect of accounting change, net of taxes
EBITDA
GAAP Net Earnings
Pro Forma Net Earnings
Net Margin
Shares Outstanding
Basic
Diluted
As a % of Net Sales
Other Cost of Sales
Cost of Sales
Operating Expenses
SG&A Expenses
Y/Y Change
Net Sales
QVC Sales
Other Sales
Cost of Sales
SG&A Expenses
Depreciation and Amortization
Stock Based Compensation
Operating Cash Flow
Operating Income
Source: Company reports and JPMorgan estimates.
196
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 122: LINTA Annual Balance Sheet
$ in millions
FY-06
FY-07E
FY-08E
FY-09E
Assets
Current Assets :
Cash and cash equivalents
Trade and other recievables
Inventory, net
Derivative instruments
Current deferred tax asset
Other current assets
Total current assets
Working Capital Current Assets
946.0
977.0
831.0
12.0
159.0
59.0
2,984.0
2,038.0
797.8
1,127.4
863.6
0.0
124.0
76.3
2,989.1
2,191.3
956.4
1,162.4
833.9
0.0
124.0
80.4
3,157.1
2,200.7
1,691.6
1,231.8
883.7
0.0
124.0
85.2
4,016.4
2,200.8
Investments in available-for-sale-securities and other cost investments
Long term derivative instruments
Investments in affiliates, accounted for using equity method
Property and equipment, net
Goodwill
Trademarks
Intangible assets subject to amortization, net
Other assets (at cost) net of accumulated amortization
Assets of discontinued operations
Total assets
2,572.0
2.0
1,358.0
912.0
5,755.0
2,450.0
3,756.0
31.0
0.0
19,820.0
2,300.0
18.0
1,312.0
1,110.9
5,854.0
2,470.0
3,484.9
44.0
0.0
19,582.9
2,300.0
18.0
1,312.0
1,350.3
5,854.0
2,470.0
3,214.3
44.0
0.0
19,719.7
2,300.0
18.0
1,312.0
1,641.3
5,854.0
2,470.0
2,964.8
44.0
0.0
20,620.5
Liabilities and Equity
Current Liabilities :
Accounts payable
Accrued liabilities
Intergroup payable receivable
Accrued stock compensation
Derivative instruments
Current portion of long term debt
Current deferred tax liabilities
Other current liabilities
Total current liabilities
475.0
136.0
663.0
81.0
0.0
11.0
0.0
91.0
1,457.0
502.5
609.1
121.8
0.0
5.0
24.0
0.0
25.0
1,287.4
528.2
640.3
121.8
0.0
5.0
24.0
0.0
25.0
1,344.4
561.6
851.0
121.8
0.0
5.0
24.0
0.0
25.0
1,588.4
Long-term debt
Long-term derivative instruments
Deferred income tax liabilities
Other liabilities
Liabilities of discontinued operations
Total liabilities
6,372.0
9.0
3,115.0
210.0
0.0
11,163.0
7,143.0
29.0
2,790.0
268.0
0.0
11,517.4
7,343.0
29.0
2,790.0
268.0
0.0
11,774.4
7,343.0
29.0
2,790.0
268.0
0.0
12,018.4
Minority interests in equity of subsidiaries
Equity attributed net assets
96.0
8,561.0
96.0
7,969.5
96.0
7,849.4
96.0
8,506.1
Total liabilities and equity
19,820.0
19,582.9
19,719.7
20,620.5
Source: Company reports and JPMorgan estimates.
197
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 123: LINTA Annual Cash Flow Statement
$ in millions
LINT Cash Flow
in millions
FY-06
FY-07E
FY-08E
FY-09E
511.0
466.5
477.0
525.2
87.0
491.0
59.0
(111.0)
4.0
(47.0)
(20.0)
0.0
35.0
(262.0)
(13.0)
0.0
534.3
53.0
(35.0)
5.0
(80.0)
(2.0)
(12.0)
26.0
(263.0)
(162.0)
(8.0)
0.0
549.1
73.6
0.0
3.0
(55.0)
(8.0)
0.0
24.0
0.0
(223.0)
0.0
0.0
572.6
78.0
0.0
3.0
(55.0)
(8.0)
0.0
24.0
0.0
(223.0)
0.0
89.0
(18.0)
107.0
13.0
(60.0)
73.0
553.0
0.0
553.0
0.0
0.0
0.0
0.0
0.0
0.0
578.7
0.0
578.7
0.0
0.0
0.0
0.0
0.0
0.0
888.3
0.0
888.3
(124.1)
0.0
0.0
244.1
0.0
0.0
1,036.8
0.0
1,036.8
Cash Flow from Investing Activities:
Cash proceeds from dispositions
Net proceeds from settlement of derivatives
Capital expended for property and equipment
Net purchases of short term investments
Cash paid for acquisitions, net cash acquired
Investment in and loans to cost and equity investees
Other investing activities, net
Repurchases of subsidiary common stock
Net cash provided (used) by investing activities
0.0
0.0
(259.0)
23.0
(436.0)
(5.0)
(8.0)
(331.0)
(1,016.0)
12.0
0.0
(336.0)
0.0
(120.0)
(11.0)
(29.0)
0.0
(484.0)
0.0
0.0
(309.7)
0.0
0.0
0.0
(20.0)
0.0
(329.7)
0.0
0.0
(281.6)
0.0
0.0
0.0
(20.0)
0.0
(301.6)
Cash Flow from Financing Activities :
Borrowing of debt
Repayments of debt
Repurchase of Liberty common stock
Intergroup cash transfers, net
Repurchases of subsidiary common stock
Other financing activities, net
Net cash used by financing activities
3,227.0
(2,188.0)
(954.0)
293.0
0.0
68.0
446.0
960.0
(187.0)
(1,021.0)
0.0
0.0
(5.0)
(253.0)
200.0
0.0
(600.0)
0.0
0.0
0.0
(400.0)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
Effect of foreign currency rates on cash
Net increase in cash and cash equivalents
18.0
1.0
10.0
(148.2)
0.0
158.6
0.0
735.2
Cash and Cash equivalents at the beginning of year
Cash and Cash equivalents at end of year
945.0
946.0
946.0
797.8
797.8
956.4
956.4
1,092.1
Cash Flow From Operating Activities
Net Earnings (loss)
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities :
Cumulative effect of accounting change
Depreciation and amortization
Stock based compensation
Payments of stock based compensation
Noncash interest expense
Share of losses (earnings) of affiliates, net
Realized and unrealized losses( gains) of financial instruments, net
Losses (gains) on disposition of assets, net
Minority interests in earnings (losses) of subsidiaries
Intergroup transfers
Deferred income tax benefit
Other non cash charges (credits), net
Changes in operating assets and liabilities, net of the effects of acquisitions :
Current Assets
Inventory
Accounts Receivable
Current Liabilities
Accounts Payable
Accrued Liabilities
Implied cash from operating activities
Adjustment
Net cash from operating activities
Source: Company reports and JPMorgan estimates.
198
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Mercadolibre, Overweight ($72.85)
We believe that the rollout of the new payment system and improving take rates will
continue to drive strong growth in 2008 and 2009. We are forecasting growth in both
the marketplace and payments take rate, acceleration in high-margin advertising and
classified revenues, which positively impact the marketplace take rate, and growth in
total payment volume. Despite the fact that Mercadolibre trades at a premium to its
peers, we continue to believe the secular Latin America e-commerce growth story
remains intact and Mercadolibre is well positioned to take advantage of this trend. As
such, we reiterate our Overweight rating.
•
Improving take rates and strong GMV growth should drive
Marketplace revenues. E-commerce growth in Latin America is expected
to remain strong in 2008 and 2009 as broadband penetration and comfort
with online transactions continue to improve. We expect Mercadolibre to
continue to maintain market share and are forecasting GMV growth of 42%
in 2008 and 31% in 2009. We expect the take rate to improve to 5.1% in
2008 and 5.8% in 2009, up from 4.6% in 2007, as the company continues to
optimize its fee structure and non-GMV revenue grows faster than GMV.
As a result, we are estimating Marketplace revenue Y/Y growth of 58.3% in
2008 and 47.8% in 2009.
•
Rollout of direct payment version of MercadoPago should drive
Payments growth. Mercadolibre finished the rollout of the new direct
payment version of MercadoPago in Chili and Columbia and we expect the
new system is to be implemented through all of Mercadolibre's markets by
the end of 2008. We expect both the Marketplace, where the system is
expected to spur increased transaction growth, and the Payments segment to
benefit from the rollout. We are modeling TPV growth of 66% in 2008 and
38% in 2009 and a take rate of 9% in both 2008 and 2009, lower than the
9.5% in 2007. As a result, we are estimating Payments revenue Y/Y growth
58.1% in 2008 and 38.9% in 2009.
•
Increasing scale and higher-margin advertising and classifieds sales
should lead to improving margins. With a significant portion of its costs
fixed and no requirements to stock merchandise, we expect Mercadolibre to
continue to benefit from increasing scale. In addition, we expect growth in
high-margin advertising and classified sales to help offset growth in lowermargin payments revenue. As a result, we are estimating a 2008 EBITDA
margin improvement of ~380bps and a 2009 EBITDA margin improvement
of ~290bps.
•
2008 Drivers. In our view, the following factors will drive Mercadolibre
shares in 2008: (1) strong Latin America e-commerce growth, (2) the rollout
of the new MercadoPago system across the marketplace platform and to
third-party sellers, (3) take rate improvement in the marketplace, and (4) the
continued success of high-margin deferred payment plans.
•
Maintaining 4Q estimates. We are maintaining our 4Q’07 revenue,
EBITDA, and EPS estimates of $26.2M, $8.6M, and $0.11 (Y/Y growth of
199
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
69.8%, 237.3%, and 0% respectively). For 2007, we are modeling revenue,
EBITDA, and EPS growth of 62.3%, 223.3%, and 820.4%, respectively.
The table below outlines our current estimates:
Table 124: Mercadolibre Estimate Highlights
$ in millions
Mercadolibre
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07
F'07
F'08
F'09
F'07 Y/Y
F'08 Y/Y
F'09 Y/Y
26.2
8.6
0.11
84.5
23.9
0.21
133.7
42.9
0.58
195.5
68.4
0.86
62.3%
223.3%
820.5%
58.3%
79.3%
180.7%
46.2%
59.2%
49.0%
27.0
8.0
0.10
85.1
22.8
0.21
131.3
39.7
0.53
185.8
61.4
0.82
63.5%
207.8%
839.5%
54.3%
74.1%
152.4%
41.5%
54.7%
54.7%
Source: Company reports, FactSet, and JPMorgan estimates.
Key Financial Metrics & Forecasts
The following tables summarize our revenue forecast by business segment and our
estimates for Y/Y growth in the marketplace and payments segments through 2009.
Table 125: Mercadolibre Marketplace Forecasts
US$ in Millions, unless otherwise noted
2006
1,075.1
76.9%
2007E
1,508.2
40.3%
2008E
2,147.9
42.4%
2009E
2,818.3
31.2%
Take Rate
4.2%
4.6%
5.1%
5.8%
Marketplace Revenues
44.7
69.7
110.4
163.1
GMV per successful item (US$)
Revenue per successful item (US$)
Successful items sold (millions)
77.9
3.24
13.8
84.1
3.89
17.9
92.8
4.77
23.1
97.7
5.66
28.8
2006
89.0
131.2%
8.3%
2007E
155.7
74.9%
10.3%
2008E
258.7
66.2%
12.0%
2009E
358.1
38.4%
12.7%
8.2%
9.5%
9.0%
9.0%
7.3
14.7
23.3
32.3
Gross Merchandise Volume (GMV)
% Change Y-Y
Source: Company reports and JPMorgan estimates
Table 126: MercadoPago Operating Metrics
US$ in Millions, unless otherwise noted
Total Payment Volume (TPV)
% Change Y-Y
% of GMV
Take Rate
Payments Revenues
Source: Company reports and JPMorgan estimates
200
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
Our 2008 estimates call for Y/Y revenue, EBITDA, and earnings growth of 58.3%,
79.3%, and 180.7% respectively. Specifically, we are modeling 2008 revenues,
EBITDA, and EPS of $133.7M, $42.9M and $0.58, respectively.
We are modeling 42.4% growth in marketplace GMV for 2008, with 10.4% growth
in GMV per successful item and 29% growth in successful items sold. We expect
marketplace take rates to increase throughout the year and we are modeling a take
rate of 5.1% for the year. On the payments side, we are forecasting 66.2% growth in
TPV and a decline in payments take rate to 9%, as the use of MercadoPago begins to
accelerate growth beyond the deferred payments platform. Additionally, we are
forecasting 58.3% growth in payments revenue for 2008.
Our Estimates and Outlook for 2009
We are maintaining our 2009 estimates, calling for revenue, EBITDA, and earnings
growth of 46.2%, 59.2%, and 49.0%, respectively. Specifically, we are modeling
2009 revenues, EBITDA and EPS of $195.5M, $68.4M, and $0.86.
We are modeling 31.2% growth in marketplace GMV for 2009. Consistent with our
expectations for 2008, we expect take rates to improve throughout the year as MELI
benefits from strong growth in its advertising and classifieds business. As such, we
are modeling a take rate of 5.8%, up from 5.1% in F’08. On the payments side, we
are forecasting 38.4% growth in TPV. We expect payments to continue to benefit
from high take rates and are forecasting a payments take rate of 9.0% in F’09.
Additionally, we are forecasting 38.9% growth in payments revenue for 2009.
Valuation and Rating Analysis
On an EV/EBITDA basis, MELI trades at 73.9x our F’08 estimate of $42.9M, vs. our
peer group at 44.8x, and 46.3x our F'09 estimate of $68.4, vs. our peer group at
29.5x. Given MELI‘s strong EBITDA growth prospects, 79% EBITDA growth in
F'08 vs. the peer group at 66% and 59% EBITDA growth in F’09 vs. the peer group
at 33%, as well as strong free cash flow generation (60% EBITDA conversion in
F’08), we believe such a premium is warranted.
Risks to Our Rating
We believe there are four primary risks to our Overweight rating on Mercadolibre:
•
Economic conditions: While economic conditions recently have been
healthy in many Latin American markets, in particular Mercadolibre's core
markets, the region has a history of economic turmoil and financial crises.
An economic slowdown, brought on by regional or global economic
weakness, or an economic upheaval, could negatively impact our estimates
for e-commerce growth in the region and therefore growth for
Mercadolibre.
•
Political environment and sovereign issues: Mercadolibre operates in
many countries with a history of political instability. Political instability
could affect customers’ confidence and therefore their willingness to
purchase goods online. In addition, governments may limit Internet or
201
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
commerce activities. We believe that Mercadolibre’s close work with local
governments to monitor sales practices and the ability to track cash flows
with MercadoPago mitigate some of this risk.
202
•
Expansion plans could stress resources: Mercadolibre has grown through
a number of acquisitions since its inception in 1999. As MELI looks to
grow into new product offerings and markets, it may look to acquire other
companies or be forced to spend substantial cash to develop its own
products. Either event could stress the company's financial resources.
•
Low cost of entry business model. Creating an online marketplace
requires little capital, since the owner does not need to stock merchandise
and fulfill orders. In addition, if Latin American e-commerce growth
proves to be as attractive as some projections estimate, it might attract the
interest of larger players, such as eBay, Google and Yahoo, who have
greater resources available to them than Mercadolibre. However, we
believe that the first-mover advantage and marketplace scale that
Mercadolibre has achieved act as barriers to entry for even deep-pocketed
competitors.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 127: MELI Annual Income Statement
$ in millions, except per share data
FY
2006
FY
2007E
FY
2008E
FY
2009E
Merchandise GMV
Payment GMV
1,075.1
89.0
1,508.2
155.7
2,147.9
258.7
2,818.3
358.1
Auction Revenues
Payment Revenues
Total Revenues
44.7
7.3
52.1
69.7
14.7
84.5
110.4
23.3
133.7
163.1
32.3
195.5
Blended Take rate
4.5%
5.1%
5.6%
6.2%
Total Cost of Sales
Gross Profit
Gross Margin
12.1
40.0
76.8%
18.4
66.1
78.3%
27.8
105.9
79.2%
39.4
156.1
79.8%
Product & Technology Development
Sales and Marketing
General and Administrative
Total Operating Expenses
Income From Operations
Operating Margin
3.1
23.4
8.1
34.6
5.4
10.4%
4.5
27.8
12.6
44.9
21.2
25.2%
6.1
44.3
18.0
68.4
37.6
28.1%
8.9
64.7
25.9
99.5
56.6
29.0%
Depreciation and amortization
EBITDA
EBITDA Margins
Y/Y Growth
2.0
7.4
14.2%
212.0%
2.7
23.9
28.3%
223.3%
5.3
42.9
32.1%
79.3%
11.7
68.4
35.0%
59.2%
0.5
(1.7)
(0.4)
(1.5)
(3.1)
1.5
(1.2)
(2.7)
(3.0)
(5.5)
2.0
2.0
3.0
3.0
Income Before Income Taxes
Tax Rate
Income/ asset tax benefit (expense)
Net Income before disc.
Discontinued Operations
Cumulative effect change in account. princ.
Net income (loss)
Add back non-cash effect of warrants
Pro forma Net Income
Accredition of preferred stock
Net income (loss) available to common
Pro Forma Net Income to common
2.3
35.0%
(1.2)
1.1
1.1
1.0
2.0
(0.5)
0.6
1.5
15.8
35.0%
(6.7)
9.1
9.1
2.0
11.1
(0.3)
8.8
10.8
39.6
35.0%
(13.9)
25.7
25.7
59.6
35.0%
(20.8)
38.7
38.7
25.7
25.7
25.7
38.7
38.7
38.7
Net Attributable to preferred
Net income ex. attributable to preferred
0.3
0.3
1.8
7.0
25.7
38.7
EPS ex. Attributable to preferred
Pro Forma EPS
0.02
0.12
0.21
0.43
0.58
0.58
0.86
0.87
Sharecount
13.1
24.8
44.7
44.7
Interest income
Interest expense
Exchange gains (losses)
Other income, net
Other income (expense)
Source: Company reports and JPMorgan estimates.
203
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 128: MELI Quarterly Income Statement
$ in millions, except per share data
3Q'06
4Q'06
1Q'07
2Q'07
FY07E
3Q'07
244.8
19.1
283.7
23.1
328.8
30.4
312.6
26.4
343.0
31.0
9.6
1.4
11.0
10.8
1.6
12.4
11.3
1.9
13.2
13.1
2.4
15.5
14.2
2.3
16.5
Blended Take rate
4.7%
4.7%
4.3%
4.3%
Total Cost of Sales
Gross Profit
Gross Margin
2.5
8.5
77.1%
2.7
9.6
77.8%
3.2
10.1
76.1%
Product & Technology Development
Sales and Marketing
General and Administrative
Total Operating Expenses
Income From Operations
Operating Margin
0.7
5.1
1.9
7.7
0.8
7.2%
0.8
5.5
1.9
8.2
1.4
11.6%
Depreciation and amortization
EBITDA
EBITDA Margins
Y/Y Growth
0.5
1.3
11.4%
NM
Interest income
Interest expense
Exchange gains (losses)
Other income, net
Other income (expense)
1Q'06
2Q'06
Merchandise GMV
Payment GMV
217.8
16.5
Auction Revenues
Payment Revenues
Total Revenues
Income Before Income Taxes
Tax Rate
Income/ asset tax benefit (expense)
Net Income before disc.
Discontinued Operations
Cumulative effect change in account. princ.
Net income (loss)
Add back non-cash effect of warrants
Pro forma Net Income
Accredition of preferred stock
Net income (loss) available to common
204
FY06
FY08E
2Q'08E
3Q'08E
4Q'07E
1Q'08E
4Q'08E
394.9
43.6
457.6
54.7
425.2
46.1
466.8
54.2
576.6
76.3
679.3
82.1
16.1
2.9
19.0
18.1
4.7
22.8
21.3
4.9
26.2
20.8
4.2
25.0
24.3
4.9
29.2
30.0
6.9
36.8
35.3
7.4
42.7
4.9%
5.1%
5.2%
5.1%
5.3%
5.6%
5.6%
5.6%
3.7
11.8
76.4%
3.6
12.9
78.3%
4.1
14.9
78.5%
5.2
17.6
77.2%
5.5
20.7
79.0%
5.2
19.8
79.2%
6.0
23.2
79.4%
7.8
29.0
78.8%
8.8
34.0
79.5%
0.8
6.1
2.1
8.9
1.1
8.7%
0.8
6.7
2.2
9.8
2.0
13.1%
1.0
6.3
2.7
10.0
2.9
17.7%
1.0
6.3
2.8
10.2
4.7
24.9%
1.2
7.0
3.5
11.6
6.0
26.3%
1.3
8.1
3.6
13.1
7.6
29.0%
1.2
8.5
3.7
13.4
6.4
25.6%
1.4
9.9
4.0
15.3
7.8
26.9%
1.7
11.8
5.1
18.5
10.5
28.5%
1.9
14.1
5.1
21.1
12.8
30.0%
0.5
1.9
15.7%
645.1%
0.5
1.7
12.5%
98.1%
0.5
2.6
16.5%
44.7%
0.5
3.5
21.0%
175.2%
0.6
5.3
28.0%
172.8%
0.6
6.6
28.8%
297.7%
1.0
8.6
32.8%
237.3%
1.0
7.4
29.6%
114.1%
1.2
9.0
30.9%
70.0%
1.5
12.0
32.5%
82.6%
1.7
14.5
34.0%
68.6%
0.0
(0.4)
0.1
(0.1)
(0.3)
0.1
(0.4)
(0.2)
(1.0)
(1.6)
0.1
(0.5)
(0.1)
(0.2)
(0.7)
0.3
(0.5)
(0.3)
(0.1)
(0.5)
0.1
(0.4)
(0.4)
(0.3)
(1.0)
0.4
(0.4)
(0.6)
(1.8)
(2.3)
0.4
(0.4)
(0.8)
(1.0)
(1.8)
0.6
0.4
0.5
0.5
0.6
(0.9)
(0.3)
0.4
0.5
0.5
0.6
0.5
76.1%
(0.4)
0.1
-
(0.1)
-688.2%
(0.8)
(0.9)
-
0.5
92.0%
(0.4)
0.0
-
1.5
-23.4%
0.4
1.9
-
1.9
47.1%
(0.9)
1.0
-
2.4
75.5%
(1.8)
0.6
-
4.2
33.5%
(1.4)
2.8
-
7.3
35.0%
(2.6)
4.8
-
6.8
35.0%
(2.4)
4.4
-
8.3
35.0%
(2.9)
5.4
-
11.0
35.0%
(3.9)
7.2
-
13.4
35.0%
(4.7)
8.7
-
0.1
0.1
0.2
(0.1)
(0.0)
(0.9)
0.7
(0.3)
(0.1)
(1.0)
0.0
0.2
0.2
(0.1)
(0.1)
1.9
0.1
1.9
(0.1)
1.7
1.0
0.2
1.2
(0.1)
0.9
0.6
1.1
1.7
(0.1)
0.5
2.8
0.6
3.4
(0.1)
2.7
4.8
4.4
5.4
7.2
8.7
4.8
4.4
5.4
7.2
8.7
4.8
4.4
5.4
7.2
8.7
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Pro Forma Net Income to common
1Q'06
0.0
2Q'06
(0.4)
Net Attributable to preferred
Net income ex. attributable to preferred
(0.0)
EPS ex. Attributable to preferred
Pro Forma EPS
Sharecount
FY06
3Q'06
0.1
4Q'06
1.8
1Q'07
1.1
2Q'07
1.6
(1.0)
(0.1)
0.3
1.5
0.6
0.3
0.3
0.2
(0.00)
0.00
(0.08)
(0.03)
(0.01)
0.01
0.11
0.12
0.02
0.04
13.14
13.14
13.1
13.4
13.4
FY07E
3Q'07
3.3
FY08E
2Q'08E
3Q'08E
5.4
7.2
4Q'07E
4.8
1Q'08E
4.4
4Q'08E
8.7
0.9
1.8
4.8
4.4
5.4
7.2
8.7
0.01
0.09
0.07
0.09
0.11
0.11
0.10
0.10
0.12
0.12
0.16
0.16
0.19
0.19
14.0
27.5
44.3
44.4
44.5
44.6
44.7
Source: Company reports and JPMorgan estimates.
205
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 129: MELI Annual Balance Sheet
$ in millions
Assets
Current assets
Cash and cash equivalents
Short-term investments
Accounts receivable
Funds receivable from customers
Prepaid expenses
Deferred tax assets
Other current assets
Total Current Assets
Non-current assets
Long-term investments
Property & equipment, net
Gooodwill & intangibles, net
Deferred tax assets
Other assets
Total Non-Current Assets
Total Assets
FY
2006
FY
2007E
FY
2008E
FY
2009E
7.1
6.3
2.0
10.2
0.3
2.9
0.2
29.1
20.2
48.4
2.6
18.4
0.8
4.7
0.5
95.6
45.9
48.4
3.0
29.9
1.3
7.7
0.9
137.0
88.6
48.4
3.7
41.7
1.8
11.0
1.2
196.4
2.9
21.3
0.4
0.0
24.7
53.8
1.5
4.4
23.0
0.6
0.2
29.6
125.2
1.5
5.2
23.0
0.6
0.2
30.4
167.4
1.5
6.0
23.0
0.6
0.2
31.2
227.6
5.7
9.1
2.7
1.7
0.1
9.4
13.9
3.9
2.4
3.1
16.2
23.9
6.3
3.8
3.1
23.3
34.9
9.0
5.4
3.1
Current liabilities
Accounts payable and accrued expenses
Funds payable to customers
Social security payable
Taxes payable
Loans payable
Other liabilities
Provisions
Total Current Liabilities
Non-current liabilities
Loans payable
Other liabilities
Total non-current liabilities
Total Liabilities
0.3
19.7
0.0
32.7
0.0
53.4
0.0
75.8
9.0
1.8
10.8
30.5
1.2
1.2
34.0
2.4
2.4
55.8
3.6
3.6
79.4
Mandatorily Redeemable conv. preferred stock
64.1
-
-
-
Shareholders equity
Common stock
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income
Total shareholders' equity (deficit)
Total Liabilities and shareholders' equity
0.1
2.7
(44.1)
0.5
(40.7)
53.8
0.0
122.9
(35.0)
3.2
91.2
125.2
0.0
117.5
(9.3)
3.2
111.5
167.4
0.0
115.4
29.5
3.2
148.2
227.6
Source: Company reports and JPMorgan estimates.
206
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 130: MELI Annual Statement of Cash Flows
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
Cash flows from operations
Net income
Depreciation & amortization
Interest expense (income)
Realized gains on investments
Unrealized gains on investments
Stock-based compensation expense
Cumulative effect of change in accounting
Change in fair value of warrants
Deferred income taxes
Changes in working capital
Accounts receivable
Funds receivable from customers
Prepaid expenses
Other assets
Accounts payable
Funds payable to customers
Provisions
Other liabilities
Net cash provided by operating activities
1.1
2.0
0.1
(0.2)
(0.0)
0.0
1.3
(1.3)
3.2
0.4
(6.0)
(0.2)
0.2
4.7
4.7
(0.6)
0.1
6.2
9.1
2.7
(0.4)
(0.2)
0.0
3.0
0.5
0.7
(0.6)
(8.2)
(0.5)
(0.4)
4.9
4.8
(0.3)
0.9
15.5
25.7
5.3
0.0
5.3
(0.4)
(11.5)
(0.5)
(0.3)
6.8
10.0
1.2
36.4
38.7
11.7
(3.0)
0.0
5.9
(0.7)
(11.8)
(0.6)
(0.4)
7.1
11.0
1.2
53.4
FCF = Operating Cash Flow - Capex
FCF, % of EBITDA
4.1
54.8%
11.3
47.2%
25.7
59.9%
39.7
58.1%
(4.9)
2.2
(49.9)
6.9
(0.0)
(4.2)
(47.2)
(10.7)
(10.7)
(13.7)
(13.7)
-
-
Cash flows from investing activities
Purchase of investments
Proceeds from sale of investments
Payment for purchase of DeRemate, net of cash required
Purchase of intangible assets
Purchase of property and equipment
Net cash provided by investing activities
(0.3)
(2.1)
(5.2)
Cash flows from financing activities
Increase in short term debt
Decrease in short term debt
Loans received
Loans paid
Proceeds from stock issuance
Stock options and warrants exercised
Net cash provided by investing activities
0.0
(3.0)
3.0
(9.0)
49.6
0.8
44.4
Effects of exchange rates on cash
0.2
0.4
-
-
Cash and equivalents, beginning of year
Net increase (decrease) in cash
Cash and equivalents, end of year
9.0
(1.8)
7.1
7.1
13.1
20.2
20.2
25.7
45.9
45.9
39.7
85.6
(0.0)
(3.0)
Source: Company reports and JPMorgan estimates.
207
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Monster Worldwide, Overweight ($33.91)
We believe that the market has already priced a U.S. recession in MNST’s current
stock price. Despite market skepticism, we continue to see upside potential from
Monster’s international business and cost savings initiatives that began in 2007.
Monster Worldwide remains our top mid-cap pick in our Internet Coverage universe
and we reiterate our OW rating.
• International should continue to drive growth in 2008 and 2009. We are
modeling 2008 and 2009 Monster Careers International revenue growth of
28.8% and 22.6%, respectively. Additionally, we are modeling corresponding
International ’08 and ’09 OIBDA margins of 24.9% and 28.0%, respectively,
up from our 2007 estimate of 14.7%. Additionally, we continue to believe the
company has incremental margin opportunity in its NA Monster Careers
segment as the company completes its cost cutting initiative and improves its
local penetration.
• North American revenue growth is expected to slow as U.S. economy
weakens. We believe the market is pricing in a decline in U.S. revenues of
almost 20%, in line with the last recession. However, we believe that this
scenario is too pessimistic. While we believe there will be some serious
headwinds, we are modeling 4.5% and 8.9% Y/Y revenue growth for Monster
Careers North America in 2008 and 2009, as we believe MNST will benefit
from share gains from offline dollars shifting online and a restructured MNST
will begin to recapture market share in 2009 from competitors.
• 2008 Drivers. In our view, the following factors will drive the stock in 2008:
(1) continued strength in International markets as online penetration continues
to grow, (2) continued margin improvement in International markets as
Monster benefits from increased scale and lower sales and marketing costs, (3)
margin improvement potential from cost savings initiatives that began in 2007,
and (4) execution of the remaining share buyback program.
• Maintaining 4Q estimates. We are modeling revenue, OIBDA, and pro
forma EPS of $353M, $92M, and $0.40, (Y/Y growth of 18%, 33%, and 1%
respectively). For F'07, we expect revenue and pro forma EPS growth of
20.9% and 10%, and we are modeling MNST OIBDA margins of 22.3%,
down from 25.1% in F'06.
The table below outlines our current estimates, including our newly introduced 2009
estimates.
Table 131: Monster Worldwide Estimate Highlights
$ in millions
Monster WW
JPMorgan
Revenue
OIBDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07
F'07
F'08
F'09
353
92
$0.40
1,350
301
$1.42
1,519
441
$1.90
1,727
514
$2.27
20.9%
7.3%
9.8%
12.5%
46.5%
34.0%
13.7%
16.6%
19.5%
353
90
0.38
1,351
328
1.40
1,558
419
1.84
1,812
503
2.24
21.0%
16.9%
8.2%
15.3%
27.7%
31.4%
16.3%
20.0%
21.7%
Source: Company reports, FactSet and JPMorgan estimates.
208
F'07 Y/Y
F'08 Y/Y
F'09 Y/Y
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Key Financial Metrics & Forecasts
The following table summarizes our revenue and margin assumptions by business
segment and geography through 2009.
Table 132: Monster Worldwide Revenue Estimates by Business Segment
Segment Revenue:
Monster Careers - North America
Monster Careers - International
Monster Careers Total Revenue
Monser Careers NA Y/Y Growth
Monster Careers Intl Y/Y Growth
Monster Careers Blended Y/Y Growth
2006
658.1
306.3
964.3
26.2%
63.7%
36.1%
2007E
711.0
480.6
1,191.6
8.0%
56.9%
23.6%
2008E
743.3
618.8
1,362.0
4.5%
28.8%
14.3%
2009E
809.3
758.7
1,568.0
8.9%
22.6%
15.1%
68.2%
31.8%
59.7%
40.3%
54.6%
45.4%
51.6%
48.4%
Internet Advertising & Fees Revenue
IA&F Y/Y Growth
152.3
39.1%
158.5
4.0%
157.3
-0.7%
158.9
1.0%
Total Monster Revenue
Total Monster Revenue Y/Y Growth
1,116.7
36.5%
1,350.0
20.9%
1,519.4
12.5%
1,726.9
13.7%
Monster Careers % North America
Monster Careers % International
Source: Company reports and JPMorgan estimates
Table 133: Monster Worldwide OIBDA Margin Estimates by Business Segment
NA OIBDA Margin
Intl OIBDA Margin
Monster Careers OIBDA Margin
% Careers OIBDA from NA
% Careers OIBDA from Intl
2006
37.5%
10.8%
29.0%
88.2%
11.8%
2007E
36.2%
14.7%
27.6%
78.5%
21.5%
2008E
38.5%
24.9%
32.3%
65.0%
35.0%
2009E
38.5%
28.0%
33.4%
59.4%
40.6%
IA&F OIBDA Margin
34.3%
16.8%
20.1%
20.4%
Source: Company reports and JPMorgan estimates
Our Estimates and Outlook for 2008
Our 2008 estimates call for Y/Y revenue, OIBDA, and pro forma EPS growth of
12.5%, 46.5%, and 34.0%, respectively. Specifically, we are modeling 2008
revenues, OIBDA, and pro forma EPS of $1.519B, $440.8M, and $1.90.
The online recruitment market in Europe is fractionalized along national boundaries.
Monster is focused on building its brand across Europe, while at the same time
driving efficiencies through centralized call center and sales operations. Monster has
introduced its eCommerce product to the European market earlier than it did
domestically, which we believe will drive margin in step with online adoption. We
are modeling International OIBDA margin expansion to 24.9% and 28.0% in 2008
and 2009, respectively, from 14.7% in 2007.
We believe Monster’s North American OIBDA margins will be bolstered by the
local newspaper deals MNST is signing as these partnerships will help the company
increase local penetration at a relatively low cost. Additionally, we believe MNST
will continue to sell through its ecommerce product. We are modeling NA OIBDA
margins of 38.5%, up from 36.2% in 2007.
209
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
We expect IA&F revenues to decline in 2008 as MNST focuses on revamping its site
and removes lower quality advertisers. For F’08, we are modeling IA&F revenues of
$157M, down from $159M in F’07.
Our Estimates and Outlook for 2009
We are introducing 2009 estimates calling for Y/Y revenue, OIBDA, and pro forma
EPS growth of 13.7%, 16.6%, and 19%, respectively. Specifically, we are modeling
2009 revenues, OIBDA, and pro forma EPS of $1.727B, $514M, and $2.27.
By 2009, we expect weakness in the U.S. recruiting markets to subside. In addition,
we expect the company to benefit from an increased focus on its customers'
experience and efforts to recapture market share from CareerBuilder. As such, we
expect Monster Careers- North America to see revenue growth accelerate to 8.9% in
F’09, up from 4.5% in F’08.
We expect the strong International growth trends to continue, as we expect MNST to
benefit from the continued shift of recruiting dollars online, since we believe online
penetration in International markets still remains below that of the U.S., and stronger
employment markets. In addition, we expect MNST to continue to focus on
improving its International operations and margins.
Valuation and Rating Analysis
On a P/E basis, MNST trades 17.8x our F’08 pro-forma EPS estimate of $1.90, vs.
ecommerce peers at 30.8x, a 42% discount. In addition, on an EV/EBITDA basis,
Monster trades 8.6x our 2008 EBITDA estimate of $441M, vs. its ecommerce peers
which trade at 19.2x 2008 estimates, a 55% discount. Despite current US macro
conditions, we believe such a discount is unwarranted. We reiterate our Overweight
rating.
Risks to Our Rating
Monster Worldwide’s business model is highly dependent on the macroeconomic
environment, as well as trends in the labor market. As a result, material negative
changes in the overall economy could have an impact on our revenue and earnings
estimates and could cause shares to underperform its peer group.
Our Overweight rating is largely predicated on the continued shift of classified
advertising dollars from offline media to online. As such, should this shift not
materialize to the extent we are forecasting, our estimates could be impacted to the
downside.
210
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 134: MNST Annual Income Statement
$ in millions, except per share data
Revenues:
Monster Careers
Internet Advertising & Fees
Total Revenues
Q/Q Revenue Growth
Y/Y Revenue Growth
FY
2006
FY
2007E
FY
2008E
FY
2009E
964.3
152.3
1,116.7
1,191.6
158.5
1,350.0
1,362.0
157.3
1,519.4
1,568.0
158.9
1,726.9
36.5%
20.9%
12.5%
13.7%
Salaries and Costs
Office and General
Marketing and Promotion
Unusual Inc./Expense
Amort./Intangibles
Depreciation
Non-cash stock option expense
Amortization of stock based comp
Total Operating Expenses
Pro Forma Operating Expenses
401.0
161.7
273.5
8.9
30.9
501.0
230.4
306.5
11.2
5.2
41.0
550.7
199.3
328.5
57.0
626.0
211.5
375.6
57.0
10.8
886.8
867.1
27.0
1,122.6
1,079.0
32.0
1,167.6
1,135.6
32.0
1,302.1
1,270.1
Operating Profit (Reported)
OIBDA
Adj Segment OIBDA
Operating Margins (Reported)
OIBDA Margins
229.9
280.5
332.3
20.6%
25.1%
227.4
300.9
355.1
16.8%
22.3%
351.8
440.8
471.9
23.2%
29.0%
424.8
513.8
556.5
24.6%
29.8%
OIBDA Growth Y/Y
48.6%
7.3%
46.5%
16.6%
Interest and Other Income
Pretax Income
Tax Benefit (Exp)
Losses in equity interest
Minority Interest
Income from Continuing Operations
Income from Discontinued Oper'ns
Net Income--Inc. Discon'd Business
Cumulative effect of accounting change, net of tax benefit
1x time legal / Severance
Net Income - Reported
Pro Forma Net Income
22.91
252.8
(87.7)
(9.5)
26.2
253.6
(90.0)
(10.2)
28.7
380.5
(133.2)
(4.0)
29.6
454.4
(159.0)
(4.0)
155.6
(116.5)
39.1
153.4
(0.5)
152.9
243.3
243.3
291.4
291.4
39.1
169.7
152.9
186.4
243.3
243.3
291.4
291.4
GAAP EPS
Pro Forma EPS
$0.30
$1.29
$1.17
$1.42
$1.90
$1.90
$2.27
$2.27
Diluted Shares Outstanding
131.2
131.3
127.8
127.5
Source: Company reports and JPMorgan estimates.
211
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 135: MNST Quarterly Income Statement
$ in millions, except per share data
Revenues:
Monster Careers
Internet Advertising & Fees
Total Revenues
Q/Q Revenue Growth
Y/Y Revenue Growth
Q1-06
FY 2006
Q2-06
Q3-06
Q4-06
Q1-07
FY 2007E
Q2-07
Q3-07
224.6
32.4
257.0
15%
36%
237.2
38.0
275.2
7%
39%
244.3
41.6
285.9
4%
38%
258.3
40.4
298.6
4%
33%
290.2
38.8
329.0
10%
28%
291.3
39.8
331.1
1%
20%
89.5
37.0
65.8
95.4
32.7
73.2
103.9
42.0
68.1
112.2
50.0
66.4
118.0
60.4
78.1
129.0
53.0
78.0
FY 2008E
Q2-08E
Q3-08E
Q4-07E
Q1-08E
Q4-08E
297.0
40.1
337.1
2%
18%
313.0
39.7
352.7
5%
18%
339.3
37.6
376.9
7%
15%
337.4
39.0
376.4
0%
14%
336.9
40.5
377.4
0%
12%
348.6
40.1
388.7
3%
10%
128.7
58.2
74.1
135.7
52.8
82.9
137.4
48.9
82.8
137.8
49.1
81.1
139.9
48.6
81.6
1.7
9.8
0.0
17.1
288.8
269.9
125.3
58.8
76.3
11.2
1.7
10.9
0.1
2.9
287.1
271.3
12.0
13.0
13.8
14.7
15.5
2.9
275.9
273.0
8.0
292.4
284.4
8.0
290.9
282.9
8.0
290.7
282.7
8.0
293.6
285.6
Salaries and Costs
Office and General
Marketing and Promotion
Unusual Inc./Expense
Amort./Intangibles
Depreciation
Non-cash stock option expense
Amortization of stock based comp
Total Operating Expenses
Pro Forma Operating Expenses
2.7
7.1
2.6
8.6
1.8
7.3
1.9
7.9
2.0
204.1
199.4
3.4
215.9
209.9
2.9
226.0
221.3
2.4
240.8
236.5
1.7
8.3
0.2
4.2
270.8
264.8
Operating Profit (Reported)
OIBDA
Adj Segment OIBDA
Operating Margins (Reported)
OIBDA Margins
OIBDA Growth Y/Y
52.9
64.7
75.0
20.6%
25.2%
57.0%
59.3
73.8
82.6
21.5%
26.8%
66.4%
59.8
71.9
83.9
20.9%
25.1%
43.4%
57.8
70.0
90.8
19.4%
23.4%
32.2%
58.2
72.5
90.2
17.7%
22.0%
12.0%
42.4
71.0
86.0
12.8%
21.5%
-3.8%
50.0
65.6
75.5
14.8%
19.5%
-8.7%
76.8
91.7
103.5
21.8%
26.0%
31.0%
84.5
105.5
112.3
22.4%
28.0%
45.5%
85.5
107.3
115.0
22.7%
28.5%
51.0%
86.7
109.4
118.0
23.0%
29.0%
66.8%
95.0
118.5
126.6
24.5%
30.5%
29.3%
Interest and Other Income
Pretax Income
Tax Benefit (Exp)
Losses in equity interest
Minority Interest
Income from Continuing Operations
Income from Discontinued Oper'ns
Net Income--Inc. Discon'd Business
Cumulative effect of accounting change, net of tax benefit
1x time legal / Severance
Net Income - Reported
Pro Forma Net Income
6.0
58.9
(20.4)
(4.0)
5.5
64.8
(22.1)
(2.0)
5.0
64.8
(22.7)
(2.0)
6.4
64.2
(22.5)
(1.5)
5.3
63.5
(22.4)
(1.4)
6.9
49.3
(17.4)
(3.0)
6.3
56.3
(20.0)
(3.1)
7.7
84.5
(30.3)
(2.8)
7.5
92.0
(32.2)
(1.0)
7.2
92.7
(32.4)
(1.0)
7.0
93.7
(32.8)
(1.0)
7.0
102.0
(35.7)
(1.0)
34.5
7.8
42.4
40.7
0.8
41.5
40.1
(123.9)
(83.8)
40.2
(1.2)
39.1
39.7
(0.2)
39.5
28.9
(0.3)
28.6
33.2
0.1
33.3
51.5
51.5
58.8
58.8
59.2
59.2
59.9
59.9
65.3
65.3
42.4
34.5
41.5
40.7
2.7
(83.8)
42.8
11.4
39.1
51.7
6.4
39.5
46.1
13.7
28.6
42.6
12.9
33.3
46.2
51.5
51.5
58.8
58.8
59.2
59.2
59.9
59.9
65.3
65.3
GAAP EPS
Pro Forma EPS
Diluted Shares Outstanding
$0.32
0.26
130.6
$0.31
0.31
132.0
($0.64)
0.33
130.8
$0.30
0.39
131.2
$0.30
$0.35
132.5
$0.22
$0.32
133.0
$0.25
$0.35
130.8
$0.40
$0.40
129.1
$0.46
$0.46
129.1
$0.46
$0.46
128.1
$0.47
$0.47
127.1
$0.51
$0.51
127.1
Source: Company reports and JPMorgan estimates.
212
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 136: MNST Annual Balance Sheet
$ in millions
Assets
Cash/Equivalents
Marketable securities
Accounts Receivable
Prepaids/Others
Assets Discont. Ops.
Work in Progress
Total current assets
Prop. & Equip., Net
Goodwill
Intangibles, Net
Investment in unconsolidated affiliate
Other Assets
Assets Discont. Ops.
Total assets
Liabilities and stockholders' equity
Accounts Payable and accrued expenses
Deferred Revenues
Cur.Port.LT Debt
Current liabilities of discontinued operations
Oth. Curr. Liab.
Total current liabilities
Long term debt, less current portion
Deferred income taxes
Other LT Liabs.
Long term liabilities of discontinued operations
Total Long Term Liabilities
Minority Interests
Total Liabilities
Stockholders' equity:
Common Stock
Other Equity
Paid in Capital
Accumulated other comprehensive income
Unamortized stock based compensation
Treasury Stock
Accummulated Deficit
Total stockholders' equity
Total L&S
FY
2006
FY
2007E
FY
2008E
FY
2009E
58.7
537.9
444.7
82.5
1,123.8
54.2
511.7
493.8
1,059.8
113.0
511.7
544.1
1,168.9
415.7
511.7
617.9
1,545.3
102.4
589.0
51.7
115.8
662.7
98.1
662.7
43.2
1,969.8
206.2
2,135.9
826.2
206.2
2,044.5
299.8
511.4
811.3
81.3
662.7
206.2
2,495.5
326.5
563.6
890.1
364.1
640.0
1,004.1
0.4
1.9
33.5
33.9
124.2
126.2
1.9
124.2
126.2
1.9
124.2
126.2
-
-
-
-
860.1
937.4
1,016.2
1,130.3
0.1
1,636.0
87.6
0.1
1,455.4
115.8
(464.3)
1,107.0
2,044.5
0.1
1,224.7
115.8
(221.0)
1,119.7
2,135.9
0.1
1,178.9
115.8
70.4
1,200.7
2,261.9
358.9
444.1
23.2
(614.1)
1,109.7
1,969.8
Source: Company reports and JPMorgan estimates.
213
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 137: MNST Annual Statement of Cash Flows
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
37.1
116.5
39.8
0.0
9.1
0.0
0.0
10.8
0.0
152.9
0.5
46.1
0.0
10.5
0.0
243.3
0.0
57.0
0.0
8.0
0.0
0.0
0.0
0.0
0.0
0.0
4.0
0.0
0.0
28.5
(50.3)
0.0
52.1
26.7
0.0
340.8
291.4
0.0
57.0
0.0
8.0
0.0
0.0
0.0
0.0
0.0
0.0
4.0
0.0
0.0
40.3
(73.8)
0.0
76.4
37.6
0.0
400.6
OPERATING CASH FLOWS
Net Income
Loss from Discont.
Depreciation and amortization
Accounting Change
Prov./Doubtful Acct.
Tax Effect Options
Excess benefit from stock option exercises
Special Compensation
Disposal of Fixed
Common stock issue for 401k plan and other
Deferred Income Tax
Minority Interests
Write-Off Oth. Asset
Other Operating
Changes in Working Capital
Accounts Receivable
Prepaid and Other
Deferred Revenue
Accounts payable, accrued expenses and other liabilities
Net cash provided by (used for) op activities of disc. Ops
Cash From Operations
10.8
7.1
0.0
0.0
35.2
(171.3)
(21.8)
116.6
94.0
17.8
268.2
24.5
0.0
0.0
(2.7)
10.2
(0.6)
0.0
18.6
(57.8)
(12.2)
67.3
26.5
(5.3)
260.0
FCF
212.6
194.2
248.8
302.6
(55.6)
(65.8)
(19.6)
0.0
0.0
(453.1)
(1.9)
0.0
(10.0)
0.0
0.0
0.0
0.0
0.0
(51.6)
(92.0)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
(92.0)
(98.0)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
(98.0)
(0.2)
(0.1)
0.0
0.0
92.3
0.0
54.1
0.0
0.0
0.0
43.3
0.0
0.0
0.0
0.0
0.0
(218.6)
0.0
0.0
0.0
(190.0)
0.0
0.0
0.0
0.0
0.0
0.0
(190.0)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
3.6
(137.9)
0.0
196.6
58.7
5.8
(4.5)
0.0
58.7
54.2
0.0
58.8
0.0
54.2
113.0
0.0
302.6
0.0
113.0
415.7
INVESTING CASH FLOWS
Capital Expenditures
Purchase of marketable securities
Sale and maturities of marketable securities
Payments for acq and intang assets, net of cash acq
Inv in unconsolidated affiliate
Cash funded for sale of subsidiaries
Sale of long term investment
Proceeds from sale of business, net of professional fees
Net cash used for investing activities in discountinued ops
Purch. of Invest.
Other Investing
Cash From Investing
FINANCING CASH FLOWS
Net repayments under line of credit and capital lease obligations
Payments on acquisition of debt
Purch./Sale of Stock
Stock Options
Excess tax benefit from stock option exercises
Repurchase of common stock
Structured stock repurchase
Cash funded to Hudson Highland Group
Net cash used for financing activities for discountinued ops
Repay Long Term Debt
Cap. Lease Payments
Other Financing
Cash From Financing
Foreign Exch Effects
Net Change In Cash
Cash at Beginning
Cash at End
Source: Company reports and JPMorgan estimates.
214
(10.0)
69.2
(264.7)
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Move, Inc., Neutral ($2.70)
Move has not escaped the doldrums of the real estate market in 2007, and we expect
F’07 Y/Y revenue growth to be ~1%. We see positives in the measures the company
has undertaken to streamline operations, led by new President Lorna Borenstein,
hired in May ’07, who brings Internet experience from her time at Yahoo! and eBay.
As market conditions are likely to remain challenging for the foreseeable future, we
reiterate our Neutral rating.
•
Real estate market environment remains challenging. We believe the
state of the real estate market continues to present a near-term headwind,
both operationally and due to headline risk. As such, we think it may be
difficult for Move to achieve significant revenue growth in F’08, and are
modeling only 9% revenue growth Y/Y.
•
Site improvements a step in the right direction. We believe management
is taking appropriate measures to modernize the site and run the business as
an Internet company. We were very encouraged by progress made in 3Q to
improve site speed (such as a 60% improvement in front page load time)
and search-engine friendliness, allowing search engines to index its pages.
•
Maintaining traffic remains a key challenge. Move has a significant
traffic advantage as the #1 site in the real estate space. When real estate
market conditions improve, we think a significant opportunity exists for
revenue growth, both in the current realtor-targeted products and through
ads and lead-generation. However, there is no guarantee of continued traffic
leadership, as competition in the online real estate market increases.
•
2008 Drivers. In our view, the following factors will drive the stock in
2008: (1) Real estate market conditions; (2) the extent to which Move’s
realtor clients shift their spend online; (3) the company’s new venture, being
developed by Allen Dalton; and (4) the competitive landscape of RE sites.
•
Maintaining 4Q’07 and F’07 estimates. We think the company can
achieve 3% revenue growth in 4Q, and are maintaining our revenue,
EBITDA and EPS estimates of $74M, $7.8M and $0.00, respectively, and
our F’07 estimates of $294M, $28.8M and $(0.05), respectively.
Table 138: Move Consensus Snapshot
$ in millions, except per-share data
MOVE
4Q'07E
F'07E
F'08E
F'09E
F'07E
Y/Y
F'08E
F'09E
JPM
Revenue
EBITDA
EPS
74.0
7.8
(0.00)
294.2
28.8
(0.05)
319.9
41.6
0.03
349.1
48.7
0.05
0.4%
60.1%
-149.5%
8.7%
44.4%
-161.6%
9.1%
17.2%
57.8%
Consensus
Revenue
EBITDA
EPS
72.0
10.2
-0.01
292.6
28.2
-0.04
318.3
37.6
0.04
373.7
N/A
0.17
-0.1%
56.4%
-144.3%
8.8%
33.6%
-196.0%
17.4%
NM
300.0%
Source: Company reports, FactSet, JPMorgan estimates.
215
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
Although we think real estate market conditions are likely to remain challenging in
F’08, we expect a slight improvement to Move’s operating results in the coming
year, as we think initiatives the company is undertaking to make the site more
efficient may start to pay off.
As such, we are maintaining our F’08 revenue, EBITDA and EPS estimates of
$320M, $41.6M and $0.03. Our revenue forecast implies 9% Y/Y growth, coming on
the heels of projected 1% revenue growth in F’07. We think Realtor.com revenue can
grow 10% Y/Y, and are forecasting Welcome Wagon revenue growth of 2% in F’08.
Our Estimates and Outlook for 2009
We do not, alas, have a crystal ball to predict whether F’09 will see a significant
turnaround in the fortunes of the US real estate market. At the same time, we think
that, independent of the timing of such a turnaround, the challenging conditions we
are currently seeing are likely to force the industry to more critically evaluate its
approaches to marketing. We believe such a re-examination can only benefit a
company like Move, the current traffic leader in the online real estate space. As such
we think our F’09 projection of a second consecutive year of 9% revenue growth is
fairly conservative.
For F’09, our projections call for revenue of $349M, EBITDA of $48.7M and EPS of
$0.05. We note that neither our F’08 nor our F’09 projections include any impact
from the project, thus far kept under tight wraps by the company, spearheaded by
Allen Dalton. While we think it’s likely the project will not have an immediate
material impact, near-term profitability may be affected if the project requires
significant up-front investment.
Valuation and Rating Analysis
On an EV/EBITDA basis, MOVE trades 5.6x our F’08 EBITDA estimate of $42M,
versus the Internet real estate group at 5.5x. We believe that current real estate
market conditions make significant multiple expansion unlikely at this time.
Risks to Our Rating
Move’s revenues and earnings are highly dependent on the health of the real estate
market, which is impacted by macroeconomic conditions outside of Move’s
immediate control. If the real estate market rebounds sooner than we are estimating,
there could be upside to our current estimates. If it takes MOVE longer to realign the
Welcome Wagon business than we are estimating, or the real estate market
deteriorates beyond current expectations, there could be downside to our current
estimates.
216
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 139: MOVE Annual Income Statement
$ in millions, except per share data
2006
2007E
2008E
2009E
Revenue
Related party revenue
Total Revenue
290.4
0.0
290.4
294.2
0.0
294.2
319.9
0.0
319.9
349.1
0.0
349.1
Cost of Revenue
Gross Profit
Gross Margin
65.1
225.3
77.6%
61.1
233.1
79.2%
64.4
255.5
79.9%
69.5
279.5
80.1%
Sales and Marketing
Product and website development
General and administrative
Amortization of intangible assets
Acquisition and restructuring charges
Impairment of long-lived assets
Litigation settlement
Stock based compensation
Total Expenses
Total Recurring Expenses
108.6
32.4
69.3
2.3
(0.3)
15.4
211.0
204.0
111.7
34.7
69.8
2.2
3.9
24.5
246.9
216.2
122.0
36.3
70.6
3.2
23.2
255.4
228.9
133.1
39.6
77.0
3.8
23.2
276.8
249.8
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
(2.4)
15.0
-0.8%
5.2%
(13.7)
16.9
-4.7%
5.7%
0.2
26.6
0.1%
8.3%
2.7
29.7
0.8%
8.5%
24.5
8.4%
357.8%
28.8
9.8%
17.9%
41.6
13.0%
44.4%
48.7
14.0%
17.2%
Interest Income
Convertible preferred stock dividends
Other, Net
Gain on settlement of distrib agreement
Total Other, Reported
Total Other, Pro Forma
7.3
(3.6)
17.4
21.1
21.1
10.0
(5.0)
1.2
6.2
6.2
10.6
(5.0)
5.6
5.6
10.9
(5.0)
5.9
5.9
Income Before Taxes
18.7
(7.6)
5.8
8.6
1.0
0%
7.6
EBITDA
EBITDA margin
Y/Y EBITDA Growth
Income Taxes
Tax Rate
Inc From Cont Ops After Taxes
0.1
0.6
18.5
(8.2)
1.0
0
4.8
Gain from discontinued operations
Extraordinary Item
-
-
-
-
Reported Net Income
FAS 123 Adjustment
Reported Net Income W/ FAS 123
18.5
18.5
(8.2)
(8.2)
4.8
4.8
7.6
7.6
Reported EPS
0.12
(0.05)
0.03
0.05
Diluted Shares
161
166
157
159
% of Total Revenue
Cost of Revenue
Sales and Marketing
Product and website development
General and administrative
22.4%
37.4%
11.2%
23.9%
20.8%
38.0%
11.8%
23.7%
20.1%
38.1%
11.3%
22.1%
19.9%
38.1%
11.3%
22.1%
Y/Y Change
Revenue
Sales and Marketing
Product and website development
General and administrative
15%
19%
47%
-16%
1%
3%
7%
1%
9%
9%
5%
1%
9%
9%
9%
9%
Source: Company reports and JPMorgan estimates.
217
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 140: MOVE Quarterly Income Statement
$ in millions, except per share data
75.7
Q4-06
71.8
71.8
FY 2007E
Q1-07
71.0
71.0
Q2-07
73.6
73.6
Q3-07
75.6
75.6
Q4-07E
74.0
74.0
FY 2008E
Q1-08E
76.0
76.0
Q2-08E
81.1
81.1
Q3-08E
82.5
82.5
Q4-08E
80.4
80.4
16.4
57.5
77.8%
16.9
58.7
77.6%
15.5
56.4
78.5%
14.7
56.4
79.4%
15.3
58.4
79.3%
16.0
59.6
78.9%
15.2
58.8
79.4%
15.2
60.8
80.0%
16.5
64.6
79.7%
16.7
65.8
79.8%
16.1
64.3
80.0%
24.9
7.9
18.7
0.7
3.4
55.5
51.4
28.0
8.5
17.5
0.6
2.5
57.1
54.0
28.6
8.2
17.3
0.5
(0.3)
4.2
58.6
54.2
27.1
7.9
15.7
0.5
5.3
56.5
50.7
27.4
8.5
16.1
0.5
0.0
0.0
0.0
5.4
58.0
52.0
27.3
9.0
17.9
0.5
0.0
0.0
0.0
7.8
62.6
54.3
28.3
8.3
19.1
0.5
0.0
0.0
3.9
5.9
66.0
55.7
28.8
8.8
16.7
0.7
0.0
0.0
0.0
5.3
60.3
54.3
29.3
8.9
17.2
0.8
0.0
0.0
0.0
5.6
61.8
55.4
31.2
9.3
18.3
0.8
0.0
0.0
0.0
5.6
65.2
58.8
31.3
9.2
18.1
0.8
0.0
0.0
0.0
5.7
65.1
58.6
30.2
8.8
17.1
0.8
0.0
0.0
0.0
6.3
63.2
56.1
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
(2.8)
1.3
-4.1%
1.8%
0.4
3.5
0.5%
4.8%
0.2
4.5
0.2%
6.0%
(0.1)
5.7
-0.2%
7.9%
(1.6)
4.3
-2.2%
6.1%
(4.2)
4.1
-5.7%
5.6%
(6.4)
3.9
-8.5%
5.2%
(1.5)
4.5
-2.1%
6.1%
(1.0)
5.4
-1.4%
7.1%
(0.6)
5.8
-0.8%
7.1%
0.7
7.2
0.8%
8.7%
1.2
8.3
1.5%
10.3%
EBITDA
EBITDA margin
Y/Y EBITDA Growth
3.9
5.6%
57.7%
4.7
6.4%
64.4%
7.4
9.8%
160.0%
8.5
11.8%
NA
7.1
10.0%
84.7%
6.9
9.4%
46.5%
7.0
9.2%
-6.2%
7.8
10.6%
-7.5%
8.9
11.7%
24.8%
9.3
11.4%
33.8%
11.2
13.5%
60.4%
12.3
15.3%
57.2%
Interest Income
Convertible preferred stock dividends
Other, Net
Gain on settlement of distrib agreement
Total Other, Reported
Total Other, Pro Forma
1.6
(0.9)
0.1
0.8
0.8
1.8
(0.9)
0.4
1.3
1.3
1.9
(0.9)
0.1
1.1
1.1
1.9
(0.9)
16.8
17.9
17.9
2.3
(1.2)
0.8
1.8
1.8
2.5
(1.2)
(0.4)
0.9
0.9
2.6
(1.2)
0.7
2.0
2.0
2.6
(1.2)
0.1
1.4
1.4
2.6
(1.2)
1.4
1.4
2.6
(1.2)
1.4
1.4
2.7
(1.2)
1.4
1.4
2.7
(1.2)
1.4
1.4
Income Before Taxes
(2.0)
1.7
1.3
17.7
0.2
(3.3)
(4.4)
(0.1)
0.3
0.8
2.1
2.6
Income Taxes
Tax Rate
Inc From Cont Ops After Taxes
0%
(2.0)
0%
1.7
0%
1.3
0.1
17.6
0.1
0%
0.2
0.2
0%
(3.5)
0.2
0%
(4.6)
0.2
0%
-0.3
0.3
0%
(0.0)
0.2
0%
0.6
0.2
0%
1.9
0.3
0%
2.4
Gain from discontinued operations
Extraordinary Item
-
-
-
-
-
-
-
-
-
-
-
-
Revenue
Related party revenue
Total Revenue
Cost of Revenue
Gross Profit
Gross Margin
Sales and Marketing
Product and website development
General and administrative
Amortization of intangible assets
Acquisition and restructuring charges
Impairment of long-lived assets
Litigation settlement
Stock based compensation
Total Expenses
Total Recurring Expenses
218
FY 2006
Q1-06
69.0
69.0
Q2-06
73.9
Q3-06
75.7
73.9
16.3
52.7
76.4%
Imran Khan
(1-212) 622-6693
[email protected]
Reported Net Income
FAS 123 Adjustment
Reported Net Income W/ FAS 123
North America Equity Research
02 January 2008
(2.0)
1.7
17.6
17.6
0.2
0.2
(3.5)
(3.5)
(4.6)
1.7
1.3
1.3
(2.0)
Reported EPS
(4.6)
(0.3)
(0.3)
(0.0)
(0.0)
0.6
0.6
1.9
1.9
2.4
2.4
(0.01)
0.01
0.01
0.09
0.00
(0.02)
(0.03)
(0.00)
(0.00)
0.00
0.01
0.01
Diluted Shares
149.0
165.1
164.4
165.7
167.4
154.9
155.0
155.5
156.0
156.5
157.0
157.5
% of Total Revenue
Cost of Revenue
Sales and Marketing
Product and website development
General and administrative
23.6%
36.0%
11.4%
27.1%
22.2%
37.9%
11.4%
23.7%
22.4%
37.9%
10.8%
22.9%
21.5%
37.7%
11.0%
21.9%
20.6%
38.6%
12.0%
22.7%
20.7%
37.1%
12.3%
24.4%
21.1%
37.4%
11.0%
25.3%
20.6%
38.9%
11.9%
22.5%
20.0%
38.6%
11.7%
22.6%
20.3%
38.5%
11.5%
22.6%
20.2%
38.0%
11.2%
21.9%
20.0%
37.5%
11.0%
21.2%
Y/Y Change
Revenue
Sales and Marketing
Product and website development
General and administrative
22%
11%
79%
14%
17%
23%
67%
-11%
14%
28%
40%
-22%
8%
15%
17%
-35%
3%
10%
9%
-14%
0%
-3%
7%
3%
0%
-1%
2%
10%
3%
6%
11%
6%
7%
7%
4%
7%
10%
14%
3%
2%
9%
11%
11%
-5%
9%
5%
0%
2%
Q/Q change
Revenue
Sales and Marketing
Product and website development
General and administrative
3.6%
5.4%
16.0%
-23.0%
7.1%
12.7%
7.6%
-6.5%
2.4%
2.3%
-3.1%
-0.9%
-5.1%
-5.5%
-3.1%
-9.5%
-1.1%
1.3%
7.7%
2.5%
3.7%
-0.5%
5.7%
11.5%
2.6%
3.6%
-7.8%
6.4%
-2.1%
1.9%
5.7%
-12.8%
2.6%
1.8%
0.9%
3.1%
6.7%
6.4%
4.9%
6.7%
1.8%
0.4%
-0.9%
-1.4%
-2.5%
-3.8%
-4.2%
-5.6%
Source: Company reports and JPMorgan estimates.
219
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 141: MOVE Annual Balance Sheet
$ in millions
FY-06E
Assets
Cash and cash equivalents
Restricted cash
Short term investments
Marketable securities
Accounts receivable, net
Current portion of distribution expense
Assets of discontinued operations
Other current assets
Total Current Assets
Prepaid distribution expense, net of current portion
Property and equipment, net
Goodwill, net
Intangible assets, net
Restricted cash
Other assets
Total Long Term Assets
Total Assets
Liabilities
Accounts payable
Accrued expenses
Accrued litigation settlement
Accrued distribution obligation
Obligation under capital leases
Deferred revenue
Deferred revenue from related parties
Liabilities of discontinued operations
Total Current Liabilities
Distribution obligation, net of current portion
Obligation under capital leases
Deferred revenue
Deferred revenue from related parties
Other non-current liabilities
Total Long Term Liabilities
FY-07E
14.9
143.0
28.1
165.1
18.3
34.5
210.6
18.5
18.5
230.2
36.2
23.9
15.8
3.3
1.6
80.8
311.0
5.2
25.9
2.0
51.8
84.9
0.7
1.9
2.5
87.4
99.9
123.7
311.0
29.2
23.9
16.7
4.3
1.2
75.4
285.9
4.9
26.7
1.9
50.1
83.6
2.2
2.5
4.7
Total Liabilities
88.3
Convertible preferred stock
96.2
Shareholder Equity
Total Equity
101.5
Total Liabilities + Equity
285.9
Source: Company reports and JPMorgan estimates.
220
FY-08E
63.3
165.1
20.1
20.1
268.6
34.2
23.9
15.8
3.3
1.6
78.8
347.4
5.6
28.2
2.0
56.3
92.1
0.7
1.9
2.5
94.6
99.9
152.8
347.4
FY-09E
104.9
165.1
22.0
22.0
313.9
31.6
23.9
15.8
3.3
1.6
76.2
390.1
6.2
30.8
2.0
61.5
100.4
0.7
1.9
2.5
102.9
99.9
187.2
390.1
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 142: MOVE Annual Cash Flow Statement
$ in millions
2006
Operating Cash Flows
Net income
Depreciation
Amortization of intangibles
Gain on sales of ppe
Accretion of distribution agreement
Imrairment of long-lived assets
Provision for doubtful accounts
Acquisition and restructuring charges
Stock-based charges
Gain on settlement of distribution agreement
Write down of investments
Realized loss on sale of marketable securities
Non-cash convertible preferred stock dividends
Write off of capitalized software
Change in market value of embedded derivative liab
Other non-cash items
Changes in working capital
Accounts receivable
Prepaid distribution expense
Restricted cash
Other assets
Accounts payable and accrued expenses
Accrued distribution agreement
Deferred revenue
Deferred revenue from related parties
Cash From Operations
FCF
Investing Cash Flows
Purchases of property and equipment
Proceeds from the surrender of life insurance
Purchases of short term investments
Maturities of short-term investments
Proceeds from sale of marketable equity securities
Purchase of intangible assets
Proceeds from sale of assets
Other assets
Acquisitions, net of cash acquired
Cash From Investing
Financing Cash Flows
Proceeds from payment of stockholders' notes
Proceeds from exercise of stock options, warrants and shares issuances under employee stock purchase
plan
Proceeds from the sale of convertible preferred stock
Payments on capital leases
Restricted Cash
Repayment of notes payable
Issuance of notes receivable
Repurchase of common stock
Settlement of a stock issuance obligation
Transfer to restricted cash
Cash From Financing
Net Cash provided by discontinued operations
Net Increase (decrease) in cash
Foreign Exch Effects
Beginning Cash
Ending Cash
2007E
2008E
2009E
22.1
10.5
2.3
2.2
15.7
(0.3)
(29.1)
(3.0)
(14.7)
(17.1)
5.8
23.4
(4.5)
11.5
2.2
(0.3)
1.0
24.9
(0.7)
(0.1)
(3.5)
(0.9)
(3.3)
8.2
(7.6)
30.6
4.8
15.0
3.2
0.9
23.2
1.5
(3.3)
5.0
(0.2)
48.7
7.6
19.0
3.8
0.9
25.5
1.6
(3.6)
5.5
(0.2)
58.5
10.5
12.6
35.7
42.1
(12.9)
26.3
(30.3)
-
(18.0)
5.2
(87.3)
65.2
15.7
(13.0)
-
(16.4)
-
(9.6)
(26.7)
0.3
(19.5)
6.9
3.1
(13.0)
1.4
(16.4)
1.4
(2.7)
(1.9)
4.9
2.1
(1.9)
(0.5)
(1.9)
(0.5)
13.3
35.2
41.6
14.9
28.1
28.1
63.3
63.3
104.9
1.6
13.3
14.9
Source: Company reports and JPMorgan estimates.
221
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Omniture, Overweight ($34.95)
F’07 has seen Omniture further its lead in the Web Analytics space, most notably
through the acquisition of Visual Sciences, announced in 4Q and expected to be
completed in 1Q’08. The company’s prospects for customer additions, higher ASPs
and improved profitability give us continued confidence in our Overweight thesis.
•
Three levers for growth. With the Visual Sciences acquisition, we believe
Omniture could achieve a customer count in excess of 5,000 by the middle
of F’08. As products such as SearchCenter, TouchClarity and Offermatica
get sold across a larger customer base, we think ASPs could begin to rise.
Finally, we expect increased scale to pay off in the form of improved
profitability.
•
Acquisition integration will be key. The Visual Sciences deal is
Omniture’s biggest to date, and we believe navigating the integration is a
near-term risk factor. However, we think management is highly cognizant of
the challenges in bringing together two firms, and do not think executive
focus on a successful integration is in short supply. Additionally, we think
the rapid DOJ approval for the acquisition was a positive, as it minimized
the period of time when Visual Sciences’ operations were in regulatory
limbo.
•
2008 Drivers. In our view, the following factors will drive the stock in
2008: (1) Integration of Visual Sciences; (2) impact from changes in
competitive environment, including both paid competitors and free analytics
offerings from Google and Microsoft; (3) pace of customer adds; (4)
international growth; (5) ability to raise ASP through up-sell and cross-sell;
and (6) profitability improvements.
•
Maintaining 4Q’07 and F’07 estimates. We are maintaining our 4Q
revenue, EBITDA and pro forma EPS estimates of $40.7M, $7.3M and
$0.08, respectively, and our F’07 revenue, EBITDA and pro forma EPS
estimates of $140.7M, $22.4M and $0.20, respectively.
Table 143: Omniture Consensus Snapshot
$ in millions, except per-share data
OMTR
4Q'07E
JPM
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
$
41
7
0.08
42
7
0.08
F'07E
$
141
22
0.20
143
22
0.20
Source: Company reports, FactSet, JPMorgan estimates.
222
F'08E
$
213
37
0.39
216
38
0.41
F'09E
$
Y/Y
F'07E
F'08E
F'09E
309
71
0.70
75.8%
180.6%
-349.6%
51.2%
66.3%
95.0%
45.0%
90.1%
80.2%
314
73
0.69
78.2%
177.1%
-348.3%
51.6%
70.6%
108.2%
45.2%
91.8%
67.4%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
The Growth Trajectory
Our Overweight thesis for Omniture is based on three key points:
•
Customer additions. The company estimates that, even after the Visual
Sciences acquisition is completed, its penetration among the top 10,000
Internet sites will be just north of 10%. As such, there remains significant
room for customer growth, with much of the customer base still a greenfield
opportunity.
•
ASP growth. Omniture had made two acquisitions, TouchClarity and
Offermatica, which gave it access to products with higher ASPs than the
core SiteCatalyst product. The two acquired companies did not have the
sales force scale that Omniture has. As such, we believe adding such
products gives Omniture’s sales force a significant opportunity to sell these
high-ASP products across a much wider customer base. We note that
SearchCenter, another higher-ASP product, has reached ~18%-20%
penetration among the company’s customer base, less than two years after
its initial introduction. We believe the availability of additional products for
cross-selling gives Omniture the ability to drive higher ASPs going forward:
Table 144: TouchClarity and Offermatica ASP, compared to SiteCatalyst
TouchClarity
Offermatica
Announced
2/14/2007
9/7/2007
Completion
3/1/2007
12/13/07
ASP estimate
1x-2x SiteCatalyst ASP
.75x-1x SiteCatalyst ASP
Source: Company Reports, JPMorgan estimates
•
Scale to drive profitability. As the company scales its technology and sales
force, we believe improved efficiencies are likely to drive profitability. The
company has noted it expects to expand non-GAAP operating margins
roughly 1% per quarter in F’08.
Our Estimates and Outlook for 2008
As the Visual Sciences acquisition has not yet been finalized, we note that our
projections for F’08 and F’09 do not include any impact from that acquisition.
We are maintaining our F’08 revenue, EBITDA and pro forma EPS estimates of
$213M, $37.3M and $0.39. We expect subscription revenue per customer to begin
rising on a Y/Y basis in the second half of the year as product cross-selling gains
momentum.
Our Estimates and Outlook for 2009
We expect Omniture to grow revenue 45% Y/Y in F’09, to $309M. We are modeling
$70.9M in EBITDA, implying 5.5% Y/Y EBITDA margin improvement, and $0.70
pro forma EPS.
Valuation and Rating Analysis
Given Omniture’s continued market share gains and strong operating leverage, we
are maintaining our Overweight rating. On an EV/EBITDA basis, Omniture trades at
60.8x our F’08 EBITDA estimate of $37M, vs. its peers at 39.8x F’08 estimates.
However, we believe Omniture’s rapid growth deserves a higher premium.
223
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
Omniture derives more than 90% of its revenue from subscription revenues. If the
company undergoes a precipitous rise in churn rates, the company’s revenue growth
could be impacted. The web analytics space is extremely competitive with over 20
companies providing analytics solutions. Should Omniture’s proposed acquisition of
Visual Sciences not go through, or go through slower than expected, the stock could
underperform. Google’s acquisition of Urchin and subsequent announcement of free
analytics may entice some mid-market customers to discontinue paying for web
analytics, or may pressure Omniture’s existing pricing dynamics. Also, if Omniture
fails to gain market share as we anticipate, our revenue estimates could prove
optimistic. Omniture’s numerous enterprise customers could choose to build
analytics solutions in-house, which could negatively impact the company’s growth
rates. Finally, should recent acquisitions be more difficult to integrate than we
expect, Omniture’s future performance could suffer as a result.
224
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 145: OMTR Annual Income Statement
$ in millions, except per share data
Subscription
Professional services and other
Total Revenues
2006
74.6
5.2
79.7
129.8
10.9
140.7
198.1
14.6
212.8
2009E
288.3
20.3
308.6
Cost of Revenues
31.8
51.6
71.7
95.3
47.9
60.1%
89.0
63.3%
141.1
66.3%
213.3
69.1%
35.2
8.7
12.1
56.1
61.5
16.5
23.1
101.1
96.4
22.2
24.7
143.3
125.3
29.1
30.4
184.7
Operating Profit (Loss)
Operating Margin
(8.1)
-10.2%
(12.0)
-8.6%
(2.3)
-1.1%
28.5
9.2%
EBITDA
EBITDA Margin
8.0
10.1%
0.6
22.4
16.0%
179.0%
3.7
37.3
17.5%
66.3%
4.1
70.9
23.0%
90.1%
5.1
Profit (Loss) before provision for income taxes
Provision for income taxes
(7.5)
0.2
(8.4)
0.3
1.8
0.4
33.6
11.8
Net Income (Loss) - GAAP
Net Income (Loss) - Pro forma
(7.7)
(2.4)
(8.7)
12.4
1.4
25.6
21.9
47.3
Gross Profit
Gross Margin
Sales & marketing
Research & development
General and administrative
Litigation settlement
Total Operating Expenses
Other Income (Expense)
EPS - GAAP (w/FAS123R)
EPS - Pro forma (ex-FAS123R)
$
$
2007E
(0.45)
(0.22)
$
$
2008E
(0.17)
0.20
$
$
0.02
0.39
$
$
0.36
0.70
Basic Shares Outstanding
Diluted Shares Outstanding
35.8
39.8
53.4
59.9
59.3
65.7
60.9
67.3
% of Revenue
Sales & marketing
Research & development
General and administrative
44.2%
10.9%
15.2%
43.7%
11.7%
16.4%
45.3%
10.4%
11.6%
40.6%
9.4%
9.8%
81.6%
197.4%
86.3%
74.0%
110.3%
76.4%
52.7%
34.5%
51.2%
45.5%
38.9%
45.0%
45.2%
31.4%
94.6%
41.1%
74.5%
88.5%
91.0%
80.3%
56.8%
34.9%
7.0%
41.8%
30.0%
31.1%
22.7%
28.9%
Growth Y/Y
Subscription
Professional services and other
Total Revenues
Sales & marketing
Research & development
General and administrative
Total Expenses
Source: Company reports and JPMorgan estimates.
225
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 146: OMTR Quarterly Income Statement
$ in millions, except per share data
Subscription
Professional services and other
Total Revenues
Cost of Revenues
1Q'06
15.5
0.9
16.4
FY 2006
2Q'06
3Q'06
17.6
19.5
1.2
1.5
18.8
21.0
4Q'06
21.9
1.6
23.5
1Q'07
27.3
1.8
29.2
FY 2007
2Q'07
3Q'07
30.6
34.4
2.9
3.0
33.5
37.4
4Q'07E
37.5
3.1
40.7
1Q'08E
43.9
3.2
47.2
FY 2008
2Q'08E
3Q'08E
46.8
51.8
3.6
3.8
50.4
55.5
4Q'08E
55.7
4.0
59.7
6.8
7.6
8.5
9.0
10.7
12.7
13.8
14.3
16.4
17.1
18.8
19.4
9.7
58.8%
11.3
59.8%
12.5
59.6%
14.5
61.7%
18.4
63.2%
20.7
61.9%
23.5
63.0%
26.3
64.8%
30.8
65.2%
33.3
66.0%
36.8
66.2%
40.3
67.5%
8.2
2.0
2.9
13.0
8.6
2.1
2.6
13.2
8.8
2.3
3.1
14.2
9.6
2.4
3.6
15.6
13.3
3.1
4.4
20.9
15.3
4.0
5.9
25.2
15.7
4.7
6.4
26.8
17.1
4.7
6.5
28.3
21.7
5.3
5.9
32.9
23.0
5.3
5.9
34.2
25.1
5.7
6.4
37.1
26.6
6.0
6.6
39.1
(3.3)
-20.4%
(2.0)
-10.6%
(1.7)
-8.0%
(1.1)
-4.8%
(2.4)
-8.4%
(4.5)
-13.3%
(3.2)
-8.6%
(1.9)
-4.7%
(2.2)
-4.6%
(0.9)
-1.8%
(0.3)
-0.6%
1.1
1.9%
(0.1)
-0.3%
1.8
9.8%
2.7
13.0%
3.5
15.1%
4.0
13.6%
5.1
15.1%
6.1
16.4%
7.3
17.9%
7.4
15.7%
8.9
17.6%
9.7
17.4%
11.3
19.0%
Other Income (Expense)
(0.0)
(0.3)
0.5
0.4
0.0
0.5
2.2
1.0
0.9
1.0
1.0
1.1
Profit (Loss) before provision for income taxes
Provision for income taxes
(3.4)
0.0
(2.3)
0.0
(1.2)
0.1
(0.7)
0.1
(2.4)
0.0
(4.0)
0.1
(1.0)
0.1
(1.0)
0.1
(1.2)
0.1
0.1
0.1
0.7
0.1
2.3
0.1
Net Income (Loss) - GAAP
Net Income (Loss) - Pro forma
(3.4)
(2.4)
(2.3)
(1.0)
(1.3)
0.2
(0.8)
0.9
(2.4)
0.9
(4.1)
1.9
(1.1)
4.4
(1.1)
5.2
(1.3)
4.6
0.0
6.0
0.6
6.7
2.2
8.4
EPS - GAAP (w/FAS123R)
EPS - Pro forma (ex-FAS123R)
$ (0.24)
$ (0.17)
$ (0.16)
$ (0.07)
$ (0.03)
$ 0.00
$ (0.02)
$ 0.02
$ (0.05)
$ 0.02
$ (0.08)
$ 0.03
$ (0.02)
$ 0.07
$ (0.02)
$ 0.08
$ (0.02)
$ 0.07
$ 0.00
$ 0.09
$ 0.01
$ 0.10
$ 0.04
$ 0.13
Basic Shares Outstanding
Diluted Shares Outstanding
14.0
14.0
14.2
14.2
45.9
52.1
47.3
53.0
47.8
54.4
49.8
56.1
57.9
64.3
58.3
64.7
58.7
65.1
59.1
65.5
59.5
65.9
59.9
66.3
% of Revenue
Sales & marketing
Research & development
General and administrative
49.8%
12.0%
17.3%
45.7%
11.0%
13.6%
42.1%
10.9%
14.6%
40.9%
10.2%
15.4%
45.7%
10.8%
15.0%
45.8%
11.9%
17.5%
42.0%
12.5%
17.1%
42.1%
11.6%
16.0%
46.1%
11.2%
12.5%
45.6%
10.5%
11.7%
45.1%
10.2%
11.5%
44.6%
10.0%
11.0%
Growth Y/Y
Subscription
Professional services and other
Total Revenues
100.2%
223.5%
104.4%
91.0%
322.8%
98.1%
75.4%
295.0%
82.6%
69.1%
96.0%
70.7%
75.8%
104.6%
77.4%
73.9%
134.5%
77.9%
75.9%
102.5%
77.8%
71.3%
101.9%
73.3%
60.8%
77.2%
61.8%
52.9%
24.8%
50.5%
50.7%
24.9%
48.6%
48.3%
27.7%
46.7%
Sales & marketing
Research & development
General and administrative
Total Expenses
69.1%
71.2%
198.4%
87.3%
44.9%
28.8%
79.3%
47.5%
35.2%
13.8%
67.2%
36.8%
38.2%
27.9%
81.3%
16.3%
62.9%
59.4%
53.9%
60.4%
78.3%
91.2%
128.7%
90.1%
77.6%
103.9%
107.4%
88.3%
78.2%
95.7%
79.6%
81.2%
63.2%
68.1%
34.4%
57.9%
49.7%
33.3%
0.4%
35.6%
59.4%
21.7%
0.1%
38.7%
55.6%
27.0%
1.2%
38.4%
Gross Profit
Gross Margin
Sales & marketing
Research & development
General and administrative
Litigation settlement
Total Operating Expenses
Operating Profit (Loss)
Operating Margin
EBITDA
EBITDA Margin
Source: Company reports and JPMorgan estimates.
226
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 147: OMTR Annual Balance Sheet
$ in millions
2006
2007E
2008E
2009E
ASSETS
Cash & cash equivalents
Short-term investments
Accounts receivable, net
Prepaid expenses & other current assets
Total Current Assets
68.3
24.1
1.6
94.0
61.8
117.0
38.6
3.8
221.2
87.0
123.0
56.7
4.2
270.8
131.1
129.2
81.8
6.0
348.2
Property and equipment, net
Intangible assets, net
Goodwill
Other assets
Total Non-Current Assets
31.1
9.8
0.3
41.2
32.5
32.2
48.0
0.6
113.4
41.7
25.8
48.0
0.9
116.4
57.2
19.4
48.0
1.3
126.0
135.2
334.6
387.1
474.1
2.6
11.4
21.9
6.1
42.0
8.0
15.2
37.8
4.7
65.8
11.7
22.4
53.7
6.9
94.7
16.9
32.3
77.5
10.0
136.7
2.2
4.1
0.0
0.5
6.8
1.4
2.1
0.2
6.8
10.6
2.1
3.1
0.4
10.0
15.6
2.5
4.5
0.5
14.4
22.5
48.8
76.4
110.3
159.2
-
-
-
-
0.1
263.1
(10.3)
0.0
(148.2)
86.4
0.1
593.9
(3.1)
(0.6)
(91.8)
258.2
276.9
315.0
135.2
334.6
387.1
474.1
Total Assets
LIABILITIES
Accounts Payable
Accrued Liabilities
Deferred Revenues
Current notes payable, capital lease obligations
Deferred Consideration related to business acq
Total Current Liabilities
Deferred revenues, less current
Notes payable, less current portion
Capital lease obligations, less current portion
Other liabilities
Total LT Liabilities
Total Liabilities
Convertible preferred stock
STOCKHOLDERS' DEFICIT
Common Stock
Additional paid-in capital
Deferred stock-based compensation
Accumulated other comprehensive income
Accumulated Deficit
Total Stockholders Equity
Total Liabilities & Owners Equity
Source: Company reports and JPMorgan estimates.
227
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 148: OMTR Annual Cash Flow Statement
$ in millions
2006
OPERATING ACTIVITIES
Net Income (Loss)
Depreciation
Amortization
Stock-based compensation
Loss on disposal of property and equipment
Patent license and litigation settlement costs
Loss on foreign currency forward contract
Changes in Working Capital
Accounts receivable, net
Prepaid expenses and other assets
Account payable
Accrued and other liabilities
Deferred revenue
Deferred gain on extinguishment of debt
Net Cash Provided by Operating Activities
2007E
2008E
2009E
(7.7)
11.4
1.6
3.2
-
(8.7)
13.4
5.7
13.4
(0.0)
0.2
1.4
15.4
6.4
17.8
-
21.9
17.0
6.4
19.0
-
(11.8)
(1.0)
(1.5)
1.1
9.9
5.2
(12.8)
(0.6)
5.0
2.1
12.0
29.8
(18.0)
(0.7)
3.7
7.1
16.6
49.7
(25.1)
(2.3)
5.2
9.9
24.7
76.7
(9.7)
15.9
25.2
44.1
(14.9)
(7.9)
(22.8)
(114.8)
(13.9)
(3.6)
(0.3)
(44.2)
(176.8)
(24.5)
(24.5)
(32.6)
(32.6)
FINANCING ACTIVITIES
Proceeds from exercise of stock options
Proceeds from employee SPP
Proceeds from issuance of preferred stock, net
Repurchase of preferred stock
Repurchase of preferred warrants
Proceeds from issuance of notes payable, capital leases
Issuance of common stock through IPO
Principal payments on notes payable, capital leases
Net Cash Provided by Financing Activities
0.2
9.6
59.2
(5.4)
63.7
2.6
0.2
142.2
(4.6)
140.4
-
-
Effect of FX on Cash & Equivalents
Net Increase in Cash & Equivalents
46.1
(6.5)
25.2
44.1
Cash & Equivalents at Beginning of Period
Cash & Equivalents at End of Period
22.2
68.3
68.3
61.8
61.8
87.0
87.0
131.1
Free Cash Flow (FCF)
INVESTING ACTIVITIES
Purchases of short-term investments, net
Purchases of property and equipment (CAPX)
Purchase of intangible assets
Payment related to foreign currency forward contract
Business acquisitions, net of cash
Net Cash Provided by Investing Activities
Source: Company reports and JPMorgan estimates.
228
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Priceline, Overweight ($118.23)
We are upgrading PCLN to Overweight from Neutral
• Current Street models don’t appreciate the growth available internationally.
Ownership of Active Hotels and Bookings gives PCLN revenue opportunities
through international sales, cross selling with the domestic market, and through
affiliate partnerships. International performance accounts for ~57% of gross
bookings, one-third of revenue and almost two-thirds (64%) of gross profit,
thereby limiting the impact of GDS negotiations and airline revenue tightening.
We expect international gross bookings to contribute $1.6B or 88% of growth in
FY’08.
• Priceline appears well positioned to take domestic market share. We believe
that domestic top-line growth will remain strong with the positive customer
response to the removal of airline booking fees and momentum in merchant
products. We expect this momentum in higher-margin merchant revenue to
continue in F'08 as we see more inventory becoming available in a weak
economy and as consumers become more price conscious. We are modeling Y/Y
merchant gross bookings growth of 7.7% and total domestic gross bookings
growth of 10.6% for F’08 (9.0% and 8.2% in F’07E).
• Margin expansion is likely given leverage and expense control. We believe
that the company operates a highly scalable business model that allows for
international expansion with few additional costs. Additionally, the domestic
business is benefiting from expense discipline programs implemented
approximately a year ago that have given the US business even more operating
leverage than the European business. We are modeling 210 bps of pro forma
operating margin expansion to 16.8%in F’08, which we note is still well below
Expedia's pro forma F'08E margin of 24.5%.
• 2008 Drivers. In our view, the following factors will drive PCLN shares in
2008: (1) comping the airline no booking fee policy, (2) expanding international
business to new markets, and (3) benefiting from the Agoda acquisition and
synergy opportunities.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $327.4M, $48.4M, and $0.59 (Y/Y growth of 26%, 85%, and
68% respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 149: Priceline Financial Snapshot
$ in millions, except per share data
Priceline
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
327.43
48.36
0.59
1,401.99
161.41
3.22
1,709.79
296.46
3.92
2,026.34
407.63
5.10
24.83%
50.77%
98.33%
21.95%
83.67%
21.90%
18.51%
37.50%
29.94%
324.29
49.07
0.56
1388.98
218.14
3.21
1689.9
299.02
3.92
1889.47
364.23
4.82
21.66%
37.08%
22.12%
11.81%
21.81%
22.96%
Source: JPMorgan estimates, Company data, and Bloomberg
229
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We are adjusting our F’08 revenue estimate to $1.71B and our full-year EBITDA
estimate to $296.5M, representing Y/Y revenue and EBITDA growth of 22% and
84%, respectively.
Current Street models don’t appreciate the growth available internationally.
We expect international revenue to grow 62% Y/Y in F’08 as a result of the
following factors:
Expansion into new regions
Priceline has significant opportunities to expand throughout Europe. Many European
countries are earlier in the online retailing adoption process thereby offering growth
not only through increasing market share but also from a growing market size. The
company estimates that Europe Internet penetration is only at 38.9% of the
population vs. 69.9% in the US.. Additionally, the introduction of offices in Ireland,
Vienna, and Portugal further rolls out the supply and distribution function to new
European locations, providing both long- (Eastern Europe) and short-term (Western
Europe) opportunities.
Figure 84: Geographic Presence
Source: Company Reports
In 3Q’07, Priceline announced its acquisition of Bangkok-and Singapore-based
Agoda. The company is an OTA specializing in merchant hotel discount bookings
throughout Asia. We believe that this is a valuable acquisition for entry into a
developing market and that clear synergies can be achieved operationally and with
inventory. We estimate that Agoda will contribute ~$76M to gross bookings in F’08
and be slightly accretive to pro forma earnings.
Cross-sales with the domestic market
Access to the more than 24,000 hotel options available at Active Hotels and
Bookings has allowed Priceline to create European vacation packages and hotel
opportunities on the domestic website, further driving international revenues and
differentiating itself from competitors with its broad overseas offering.
230
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Affiliate partnerships yield additional income
Active Hotels promotes its offerings across 1,500 websites and Booking.com
supplements this with additional affiliates. Through profitable revenue sharing
agreements, this allows the large hotel inventories to be marketed on a much broader
scale.
International hotel business growth limits the impact of airline revenue tightness and
unfavorable GDS negotiations
International performance accounts for approximately one-third of revenue and
almost two-thirds gross profit, thereby limiting the impact of GDS negotiations and
airline revenue tightening as these areas become a smaller proportion of income. We
expect international gross bookings to contribute $1.6B or 88% of growth in FY’08,
continuing this trend.
Figure 85: International Gross Bookings Growth
$ in thousands
$2,500,000
94.1%
$2,000,000
185.0%
$1,500,000
$1,000,000
625.2%
$500,000
NM
$0
2003
603.9%
2004
2005
2006
YTD06
YTD07
Source: Company data
Domestic growth looks promising.
We believe that domestic top-line growth will remain strong with the positive
customer response to the removal of airline booking fees and momentum in merchant
products. We expect this momentum in higher-margin merchant revenue to continue
in F'08 as we see more inventory becoming available in a weak economy and as
consumers become more price conscious. Furthermore, low-margin airline travel is
accounting for a smaller proportion of sales with hotels and car rentals growing at a
much faster pace. Hotel room bookings now compose the majority of sales and are
expected to grow at the fastest pace. We are modeling Y/Y merchant gross bookings
growth of 7.7% and total domestic gross bookings growth of 10.6% for F’08 (9.0%
and 8.2% in F’07E).
231
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Figure 86: Units Sold by Type of Product
15,000
10,000
5,000
Q1-05
Q2-05 Q3-05
Q4-05 Q1-06
Q2-06 Q3-06 Q4-06
Air - Total Airline Tickets (000's)
Q1-07 Q2-07
Q3-07
Hotel - Total Room Nights (000's)
Car - Total Rental Car Day s (000's)
Source: Company reports and JPMorgan estimates.
Margin expansion is likely given leverage and expense control
We believe that the company operates a highly scalable business model that allows
for international expansion with few additional costs. Additionally, the domestic
business is benefiting from expense discipline programs implemented approximately
a year ago that have given the US business even more operating leverage than the
European business. We are modeling 210 bps of pro forma operating margin
expansion to 16.8%, which we note is still well below Expedia's pro forma F'08E
margin of 24.5%.
Table 150: Historical Operating Margin Trends
$ in millions
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
F'05
35.9
60.4
3.7%
6.3%
F'06
62.0
98.8
5.5%
8.8%
F'07E
128.2
206.3
9.1%
14.7%
F'08E
254.5
286.5
14.9%
16.8%
F'09E
360.6
393.6
17.8%
19.4%
Source: JPMorgan estimates and Company data
Our Estimates and Outlook for 2009
We are introducing F’09 revenue, EBITDA, and EPS estimates of $2.03B, $407.6M,
and $5.10, which represents 19%, 38%, and 30% Y/Y growth, respectively. Again,
growth should be mostly supported by the international market where we see gross
bookings increases of 39% Y/Y, moving the international market to account for an
expected 70% of gross bookings. We expect the company to strategically support the
international market by concentrating on developing its presence in Eastern Europe
and Asia as the Western European market matures. We see an additional 260 bps of
pro forma operating margin expansion due to leverage of the business and increases
in merchant revenues.
Valuation and Rating Analysis
On a price/non-GAAP FCF basis, PCLN shares are trading at 19x our F’08 nonGAAP FCF estimate of $281M versus its peer group, which is trading at 24x F’08
estimates. We believe that this discount is unjustified given its high F’08 non-GAAP
FCF estimated growth rate of 90% vs. the peer group average of 32%. As such, we
rate this stock Overweight.
232
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
Priceline shares could underperform other companies in our coverage universe if its
domestic growth is pressured by competition from other OTA's or suppliers, if it has
difficulty obtaining merchant inventory, if it experiences increased competition in the
international market, or if sales and marketing and technology expenses increase
significantly.
233
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 151: PCLN Annual Income Statement
$ in millions, except per share data
FY-06
FY-07E
FY-08E
FY-09E
904.2
213.9
5.0
1,123.1
1,123.1
1,005.9
389.0
7.0
1,402.0
1,383.4
1,088.0
615.9
5.9
1,709.8
1,709.8
1,164.4
846.0
16.0
2,026.3
2,026.3
Cost of Revenue (Reported)
Cost of Revenue (Pro Forma)
722.0
721.0
772.9
772.9
931.6
931.6
1,044.8
1,044.8
Gross Profit (Reported)
Gross Profit (Pro Forma)
Gross Margin Pro Forma)
401.1
401.0
35.7%
629.1
610.5
43.5%
778.2
778.2
45.5%
981.5
981.5
48.4%
Advertising
Sales & Marketing
Personnel
General and Administrative
Information Technology
Depreciation & Amortization
Unusual Expenses
FAS123R
145.7
42.1
68.0
28.4
9.7
33.4
0.1
15.1
209.7
48.5
84.3
93.0
13.6
35.8
16.1
259.9
59.6
101.1
44.1
17.1
38.0
18.0
314.1
70.5
117.1
48.8
23.4
42.0
20.0
Adjustments to Operating Exp
Total Operating Exp (Reported)
Total Operating Exp (Pro Forma)
(26.5)
339.1
302.1
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
62.0
98.8
5.5%
8.8%
(80.6)
500.9
404.2
128.2
206.3
9.1%
14.7%
(28.0)
523.7
491.7
254.5
286.5
14.9%
16.8%
(28.0)
620.9
587.9
360.6
393.6
17.8%
19.4%
EBITDA
Y/Y change
107.1
54.7%
161.4
50.8%
296.5
83.7%
407.6
37.5%
Interest (Inc & Exp)
Other
4.3
(0.6)
15.8
(3.4)
18.8
0.4
20.0
-
Adjustments to Other Income
Total Other (Reported)
Total Other (Pro Forma)
3.6
3.6
12.5
9.3
19.2
19.2
20.0
20.0
EBT (Reported)
EBT (Pro Forma)
Income Tax, Reported
Income Tax Pro forma
Equity in income (loss) of minority interest
Equity in income of minority int. (Pro Forma)
Net Income (Reported)
Net Income w/ FAS 123R Adjustment
Net Income (Pro Forma)
Preferred Stock Dividend
65.6
102.5
12.4
(15.7)
(3.6)
(3.7)
74.5
74.5
83.1
(1.9)
140.6
215.6
15.3
(35.2)
(3.9)
(4.5)
152.0
152.0
176.0
-
273.7
305.7
(76.6)
(61.1)
197.0
197.0
244.5
-
380.7
413.7
(106.6)
(86.9)
274.1
274.1
326.8
-
EPS (Reported)
EPS (Pro Forma)
$1.62
$2.03
$3.22
$3.96
$3.92
$4.87
$5.10
$6.08
Shares Outstanding (Basic)
Shares Outstanding (Diluted GAAP)
Shares Outstanding (Diluted Pro Forma)
38.7
44.7
40.9
37.6
42.6
42.6
38.2
50.0
50.0
40.1
53.6
53.6
Merchant Revenues
Agency Revenues
Other Revenues
Total Revenue
Pro Forma Revenue
Source: Company reports and JPMorgan estimates.
234
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 152: PCLN Quarterly Income Statement
$ in millions, except per share data
FY-2006
Q1-06
Q2-06
Q3-06
Q4-06
FY-2007E
Q1-07
Q2-07
Q3-07
Q4-07E
FY-2008E
Q1-08E
Q2-08E
Merchant Revenues
Agency Revenues
Other Revenues
Total Revenue
Pro Forma Revenue
210.4
30.4
1.1
241.9
241.9
250.5
55.9
1.2
307.7
307.7
238.6
73.3
1.6
313.5
313.5
204.6
54.3
1.1
260.1
260.1
246.0
54.5
0.9
301.4
285.5
254.9
98.3
2.6
355.9
353.6
275.2
139.6
2.5
417.3
416.9
229.8
96.5
1.1
327.4
327.4
264.4
95.7
1.1
361.2
361.2
Cost of Revenue (Reported)
Cost of Revenue (Pro Forma)
169.7
169.3
201.8
201.5
189.9
189.5
160.6
160.6
181.7
181.7
198.7
198.7
215.0
215.0
177.6
177.6
Gross Profit (Reported)
Gross Profit (Pro Forma)
Gross Margin Pro Forma)
72.2
72.6
30.0%
105.8
106.1
34.5%
123.5
122.3
39.0%
99.5
99.9
38.4%
119.7
103.8
36.4%
157.2
154.9
43.8%
202.3
201.9
48.4%
Advertising
Sales & Marketing
Personnel
General and Administrative
Information Technology
Depreciation & Amortization
Unusual Expenses
FAS123R
31.3
9.6
13.4
5.6
2.3
7.9
0.1
3.1
39.4
10.7
15.0
7.1
2.3
8.4
41.2
11.2
21.7
6.6
2.6
8.7
33.8
10.6
17.9
9.0
2.6
8.5
43.3
11.4
18.3
63.9
2.9
8.5
52.8
11.5
20.0
9.7
3.2
9.0
3.8
3.5
4.7
3.2
Adjustments to Operating Exp
Total Operating Exp (Reported)
Total Operating Exp (Pro Forma)
-5.7
73.5
64.7
-5.8
86.8
77.1
(4.4)
91.9
84.0
(10.6)
86.9
76.3
Operating Profit (Reported)
Operating Profit (Pro Forma)
Operating Margin (Reported)
Operating Margin (Pro Forma)
-1.2
7.9
-0.5%
3.3%
19.0
29.0
6.2%
9.4%
31.6
38.3
10.1%
12.2%
EBITDA
Y/Y change
10.3
31.6
Interest (Inc & Exp)
Other
0.1
0.1
Adjustments to Other Income
Total Other (Reported)
Total Other (Pro Forma)
0.2
0.2
Q3-08E
Q4-08E
278.7
168.8
2.6
450.1
450.1
297.2
206.3
1.1
504.6
504.6
247.7
145.1
1.1
393.9
393.9
225.8
225.8
241.2
241.2
253.7
253.7
210.8
210.8
149.8
149.8
45.8%
135.4
135.4
37.5%
208.8
208.8
46.4%
250.8
250.8
49.7%
183.1
183.1
46.5%
62.3
13.1
23.1
9.0
3.3
9.1
51.4
12.4
22.9
10.5
4.2
9.1
54.9
14.1
22.8
8.7
3.6
9.5
68.4
14.9
25.0
10.8
4.5
9.5
76.7
15.6
27.8
11.6
5.0
9.5
59.9
15.0
25.6
13.0
3.9
9.5
3.6
4.4
5.0
4.0
4.0
5.0
5.0
(61.2)
151.5
87.1
(6.2)
109.6
99.9
(6.2)
124.2
113.6
(7.0)
115.6
103.6
(7.0)
117.5
106.5
(7.0)
133.0
126.0
(7.0)
146.2
139.2
(7.0)
126.9
119.9
12.6
23.6
4.8%
9.1%
(31.7)
16.8
-10.5%
5.6%
47.6
55.0
13.4%
15.5%
78.1
88.3
18.7%
21.2%
34.2
46.2
10.5%
14.1%
17.9
28.9
4.9%
8.0%
75.8
82.8
16.8%
18.4%
104.6
111.6
20.7%
22.1%
56.2
63.2
14.3%
16.0%
39.0
26.1
69.6%
-35.9
-449.0%
57.8
83.0%
91.2
133.5%
48.4
85.1%
31.4
-187.2%
85.3
47.5%
114.1
25.2%
65.7
35.9%
0.6
-0.6
1.08
0.35
2.53
-0.45
5.73
-0.21
3.63
-0.33
3.46
-1.32
3.00
-1.50
3.72
0.11
3.16
0.11
4.79
0.11
7.09
0.11
(0.06)
(0.06)
1.43
1.43
2.08
2.08
-2.79
5.52
2.73
-0.26
3.30
3.03
-0.08
2.14
2.06
1.50
1.50
3.83
3.83
3.27
3.27
4.90
4.90
7.20
7.20
235
Imran Khan
(1-212) 622-6693
[email protected]
EBT (Reported)
EBT (Pro Forma)
Income Tax, Reported
Income Tax Pro forma
Equity in income (loss) of minority interest
Equity in income of minority int. (Pro Forma)
Net Income (Reported)
FAS 123R Adjustment
Net Income w/ FAS 123R Adjustment
Net Income (Pro Forma)
Net Income (Pro Forma) W/FAS 123
Preferred Stock Dividend
North America Equity Research
02 January 2008
FY-2006
Q1-06
Q2-06
(1.0)
19.0
8.1
28.9
0.7
(5.6)
(0.3)
(4.7)
0.2
(0.9)
(0.2)
(1.3)
(0.1)
12.5
Q3-06
33.03
39.71
18.11
(7.98)
(2.33)
(1.58)
48.8
Q4-06
14.66
25.73
(0.89)
(2.66)
(0.54)
(0.64)
13.2
FY-2007E
Q1-07
Q2-07
(26.22)
50.87
19.49
58.04
11.59
(14.96)
(1.71)
(9.36)
(0.09)
(1.33)
(0.40)
(1.33)
(14.7)
34.6
Q3-07
80.22
90.35
26.66
(16.09)
(2.52)
(2.72)
104.4
Q4-07E
35.73
47.73
(8.00)
(8.00)
FY-2008E
Q1-08E
Q2-08E
21.69
79.06
32.69
86.06
(6.07)
(22.14)
(6.54)
(17.21)
27.7
15.6
Q3-08E
109.51
116.51
(30.66)
(23.30)
Q4-08E
63.41
70.41
(17.75)
(14.08)
56.9
78.8
45.7
(0.1)
7.6
7.6
-0.9
12.5
23.0
23.0
0.0
48.8
30.2
30.2
(1.06)
13.2
22.4
22.4
0.00
(14.7)
17.4
17.4
(1.56)
34.6
47.3
47.3
0.00
104.4
71.5
71.5
0.00
27.7
39.7
39.7
0.00
15.6
26.2
26.2
0.00
56.9
68.8
68.8
0.00
78.8
93.2
93.2
0.00
45.7
56.3
56.3
0.00
EPS (Reported)
EPS (Pro Forma)
(0.02)
$0.19
$0.28
$0.55
$1.05
$0.72
$0.35
$0.58
-$0.44
$0.43
$0.79
$1.11
$2.27
$1.58
$0.59
$0.85
$0.32
$0.53
$1.16
$1.41
$1.55
$1.83
$0.90
$1.10
Shares Outstanding (Basic)
Shares Outstanding (Diluted GAAP)
Shares Outstanding (Diluted Pro Forma)
39.4
39.4
40.9
39.5
47.0
41.8
39.6
46.4
42.0
36.2
40.9
38.9
37.2
37.2
40.2
37.6
43.7
42.7
37.8
45.9
45.4
38.0
47.0
47.0
38.2
49.0
49.0
38.2
49.0
49.0
38.2
51.0
51.0
38.2
51.0
51.0
% of Total Revenue
Operating Expenses
Cost of Revenue (Pro Forma)
Advertising
Sales & Marketing
Personnel
General and Administrative
Information Technology
Depreciation & Amortization
26.7%
70.0%
12.9%
4.0%
5.6%
2.3%
1.0%
3.3%
25.1%
65.5%
12.8%
3.5%
4.9%
2.3%
0.8%
2.7%
26.8%
60.5%
13.2%
3.6%
6.9%
2.1%
0.8%
2.8%
29.3%
61.7%
13.0%
4.1%
6.9%
3.4%
1.0%
3.3%
28.9%
60.3%
15.2%
4.0%
6.4%
22.4%
1.0%
2.8%
28.1%
55.8%
14.9%
3.3%
5.6%
2.7%
0.9%
2.5%
27.2%
51.5%
14.9%
3.1%
5.5%
2.2%
0.8%
2.2%
31.6%
54.2%
15.7%
3.8%
7.0%
3.2%
1.3%
2.8%
29.5%
62.5%
15.2%
3.9%
6.3%
2.4%
1.0%
2.6%
28.0%
53.6%
15.2%
3.3%
5.6%
2.4%
1.0%
2.1%
27.6%
50.3%
15.2%
3.1%
5.5%
2.3%
1.0%
1.9%
30.4%
53.5%
15.2%
3.8%
6.5%
3.3%
1.0%
2.4%
Y/Y Change
Total Revenue
Merchant Rev.
Agency Rev.
Cost of Revenue (Pro Forma)
Gross Profit
Advertising
Sales & Marketing
Personnel
General and Administrative
Information Technology
Depreciation & Amortization
3.7%
-3.0%
103.6%
-3.4%
25.0%
49.0%
16.7%
19.7%
33.3%
-15.8%
45.4%
15.4%
1.6%
196.4%
0.3%
61.9%
93.9%
5.9%
54.1%
30.7%
-16.0%
65.6%
21.1%
7.4%
106.6%
6.5%
51.3%
51.6%
16.2%
56.7%
38.0%
1.7%
21.4%
27.5%
18.1%
82.4%
15.9%
53.0%
60.8%
67.9%
20.5%
40.3%
-1.5%
9.9%
24.6%
16.9%
79.4%
7.3%
43.1%
38.2%
19.1%
36.4%
1030.9%
26.2%
7.0%
15.7%
1.8%
76.0%
-1.4%
45.9%
34.0%
7.6%
32.8%
35.9%
35.2%
7.6%
33.1%
15.4%
90.4%
13.4%
65.1%
51.0%
16.9%
6.5%
35.7%
31.0%
5.4%
25.9%
12.3%
77.8%
10.6%
49.9%
52.2%
17.1%
28.0%
17.1%
63.8%
7.7%
19.8%
7.5%
75.6%
24.3%
30.4%
26.9%
23.5%
24.2%
-86.4%
24.1%
11.7%
26.5%
9.3%
71.6%
21.4%
34.8%
29.7%
28.9%
25.1%
11.6%
42.8%
5.6%
20.9%
8.0%
47.8%
18.0%
24.2%
23.2%
19.5%
20.4%
28.8%
50.9%
4.0%
20.3%
7.8%
50.3%
18.7%
22.2%
16.5%
20.3%
11.7%
24.1%
-6.0%
4.0%
Source: Company reports and JPMorgan estimates.
236
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 153: PCLN Annual Balance Sheet
$ in millions
FY-06
FY-07E
FY-08E
FY-09E
423.6
2.5
8.0
48.5
20.5
503.1
21.7
152.9
226.7
179.4
21.8
1,105.6
438.1
2.7
73.0
62.2
26.2
602.3
28.0
182.4
270.8
222.8
39.8
1,346.1
674.9
2.7
73.0
91.2
26.2
868.1
31.6
182.4
270.8
222.8
39.8
1,615.5
983.8
2.7
73.0
124.3
28.9
1,212.8
35.6
182.4
270.8
222.8
39.8
1,964.2
49.0
46.9
4.8
0.0
100.7
39.7
11.9
22.5
568.9
743.6
58.9
58.9
7.7
569.5
695.0
47.2
12.5
15.1
0.0
769.8
78.9
58.9
7.7
569.5
715.0
47.2
12.5
15.1
0.0
789.8
98.9
58.9
7.7
569.5
735.0
47.2
12.5
15.1
0.0
809.8
Common stock, $0.008 par value per share,
Treasury stock, 2,496,326 shares and 2,496,326
Additional paid-in capital
Deferred compensation
Accumulated deficit
Accumulated other comprehensive income
Total stockholders equity
13.5
0.0
0.3
(486.5)
2,070.4
0.0
(1,262.0)
26.3
348.6
0.0
0.0
0.3
(488.7)
2,154.4
0.0
(1,139.4)
49.6
576.3
0.0
0.0
0.3
(488.7)
2,403.8
0.0
(1,139.4)
49.6
825.7
0.0
0.0
0.3
(488.7)
2,732.5
0.0
(1,139.4)
49.6
1,154.4
Total liabilities and stockholders equity
1,105.6
1,346.1
1,615.5
1,964.2
Cash and cash equivalents
Restricted cash
Short-term investments
Accounts receivable
Prepaid expenses and other current assets
Total current assets
Property and equipment, net
Intangible assets, net
Goodwill
Deferred Taxes
Other assets
Total assets
Accounts payable
Accrued expenses
Deferred merchant bookings
Other current liabilities
Total current liabilities
Deferred Taxes
Other long-term liabilities
Minority Interest
Long-term debt
Total liabilities
Series B Mandatorily Redeemable Preferred Stock
Source: Company reports and JPMorgan estimates.
237
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 154: PCLN Annual Cash Flow Statement
$ in millions
FY-06
FY - 07E
FY - 08E
FY - 09E
Net income (loss)
Depreciation
Amortization
Provision for uncollectible accounts
Deferred Income Tax
Restructuring charge, net
Warrant costs
Equity in loss of investees, net
Impairments of investments in licensees
Net gain on disposal of property and equipment
Compensation expense arising from restricted stock awards
Amortization of debt issuance costs
Changes in assets and liabilities:
Accounts receivable
Prepaid expenses and other current assets
Accounts payable and accrued expenses
Other
Cash Flow from Operations
74.5
10.1
24.8
5.1
(27.8)
0.1
3.6
14.9
1.9
4.9
(21.2)
(2.6)
27.4
1.3
112.1
152.0
5.3
18.5
4.0
(7.2)
1.4
11.5
1.6
(37.5)
12.6
(2.5)
(48.4)
0.8
106.9
197.0
12.4
25.6
10.4
16.4
(9.0)
(29.0)
20.0
252.8
274.1
16.0
26.0
11.6
17.0
(15.8)
(33.1)
(2.7)
20.0
328.9
FCF
99.2
92.9
236.8
308.9
Additions to property and equipment
Purchase of short-term investments
Maturing of Investments (investing)
(Funding)Return of restricted cash and bank certificate of deposit
Equity investment and other acquisitions
Cash flow from Investing Activities
(12.9)
(112.0)
176.8
19.9
(3.1)
68.8
(14.0)
(22.4)
8.0
(0.2)
(59.2)
(87.8)
(16.0)
(16.0)
(20.0)
(20.0)
Proceeds from sale of common stock
Proceeds from issuance of convertible senior notes
Proceeds from exercise of stock options/warrants
Proceeds from sale of minority interest in subsidiary
Purchase of conversion spread hedges
Additional debt issuance costs
Excess tax benefit from stock based comp
Repurchase of stock
Cash flow from Financing Activites
345.00
14.13
(19.83)
(37.40)
(9.05)
0.28
(135.84)
157.3
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
236.8
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
308.9
438.1
674.9
674.9
983.8
Effect of exchange rate changes on cash
Net Change in Cash
338.2
9.65
(0.12)
0.57
(16.64)
(6.54)
0
1.984
14.5
Cash at the Beginning of period
Cash at the End of Period
73.1
423.6
423.6
438.1
Source: Company reports and JPMorgan estimates.
238
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Shutterfly, Overweight ($27.38)
Shutterfly’s efforts to diversify its business away from traditional photo prints and
into higher ASP products will help drive revenue growth in 2008 and 2009, in our
view. We also believe strong customer metrics in conjunction with continued digital
camera adoption will drive revenue growth. We reiterate our Overweight rating.
•
Shutterfly’s diversified product offering should drive revenue metrics.
With the purchase of Make It about Me! and branding arrangements with
companies such as Nickelodeon and Martha Stewart in 2007, we believe
Shutterfly is committed to its expansion into personalized products and higher
ASP photo merchandise. In 2008 and 2009, we believe Shutterfly will enjoy
strong growth in higher ASP product categories, which will drive stronger
overall revenue growth. We expect F’08 customer growth, order growth, and
AOV growth of 28.3%, 29.1%, and 6.2%, respectively.
•
Completion of Charlotte facility should positively impact margins in
2008. While the Charlotte facility began operations in 2007, we think the
margin impact will be felt in 2008,, once the facility has worked out any
operational kinks and begins to run near full capacity. We are forecasting F’08
margins to improve ~110bps to 6.9% from 5.8% in F'07.
•
International expansion is not likely until 2009. Currently, over 98% of
SFLY’s revenue comes from the U.S. and the company remains focused on
bolstering its platform and infrastructure to support US growth. However, we
believe SFLY will begin to look for international opportunities in F'09.
•
2008 Drivers. We believe the following factors will drive Shutterfly’s share
price in 2008: (1) continued creative marketing efforts with fast ROI (e.g.,
marketing arrangements with Target and David's Bridal), (2) introduction of
new products and/or partnerships that decrease the seasonality of the business
(e.g., the acquisition of Make It About Me! and book licensing arrangements
with Nickelodeon), and (3) print price stability.
•
Maintaining estimates. We are maintaining our 4Q’07 revenue, EBITDA,
and adjusted EPS estimates of $93.8M, $32.0M, and $0.64 (representing Y/Y
growth of 43%, 34.1%, and 31.2% respectively). For 2007, we are modeling
revenues, EBITDA, and adjusted EPS of $183.0M, $31.8M, and $0.36.
The table below outlines our current estimates, including our newly introduced 2008
estimates.
Table 155: Shutterfly Estimate Highlights
$ in millions
Shutterfly
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07
F'07
F'08
F'09
F'07 Y/Y
F'08 Y/Y
F'09 Y/Y
93.8
32.0
0.64
183.0
31.8
0.38
251.0
44.8
0.53
328.1
61.5
0.75
48.3%
53.6%
-31.7%
37.2%
40.7%
39.6%
30.7%
37.3%
41.3%
93.7
32.3
0.65
182.9
31.3
0.40
252.2
44.3
0.57
325.6
68.5
0.90
48.3%
51.1%
-28.6%
37.9%
41.5%
42.5%
29.1%
54.6%
57.9%
Source: Company reports, FactSet and JPMorgan estimates.
239
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Key Financial Metrics & Forecasts
The following table summarizes our Y/Y growth assumptions by business segment
through 2009. Detailed description of our forecast is in the following two sections.
Table 156: Shutterfly Operating Metrics
Customers
Y/Y Growth
2006A
1,734,780
42.3%
2007E
2,329,545
34.3%
2008E
2,987,472
28.2%
2009E
3,682,144
23.3%
Orders
Y/Y Growth
5,104,859
39.8%
6,842,183
34.0%
8,834,439
29.1%
11,074,806
25.4%
1.95
-1.4%
1.94
-0.7%
1.95
0.6%
1.98
1.7%
$24.16
5.1%
$26.74
10.7%
$28.41
6.2%
$29.62
4.3%
49%
51%
40%
60%
35%
65%
31%
69%
Average orders per customer
Y/Y Growth
Average Order Size
Y/Y Growth
As % of total revenues
Print Revenue
Personalized Products Revenue
Source: Company reports and JPMorgan estimates.
Our Estimates and Outlook for 2008
We are maintaining our 2008 estimates, which call for Y/Y revenue, EBITDA, and
earnings growth of 37.2%, 40.7%, and 38.8%, respectively. Specifically, we are
modeling 2008 revenues, EBITDA, and adjusted EPS of $251.0M, $44.8M, and
$0.49. We are modeling Y/Y growth in customers, orders, and AOV of 28.2%, 29.1,
and 6.2%, respectively.
As photo prints have become increasingly commoditized, Shutterfly has pursued a
strategic move away from a print-focused approach. We estimate photo print
revenues will represent 40% and 35% of revenues in F’07 and F’08, respectively
(from 49% in F’06). At the same time, growth in non-print revenues, such as greeting
cards, photobooks, and calendars has increased. For F’08, we estimate Y/Y growth
rates for personalized products of 48% and photo prints of 21%.
Our Estimates and Outlook for 2009
We are introducing our 2009 estimates and are calling for revenue, EBITDA, and
earnings growth of 30.7%, 37.3%, and 44.3%, respectively. Specifically, we are
modeling 2009 revenues, EBITDA and adjusted EPS of $328.1M, $61.5M, and
$0.71. We are modeling Y/Y growth in customers, orders, and AOV of 23.3%,
25.4%, and 4.3%, respectively.
Valuation and Rating Analysis
We believe Shutterfly should be valued relative to companies with the following
attributes: (1) online commerce business models, (2) subscription driven business
models, (3) 25%+ top-line growth potential, (4) exposure to the online printing
market, and (5) a data hosting offering.
SFLY trades at a discount to its peers. On an EV/EBITDA basis, SFLY trades at 13x
our F’08 EBITDA estimate of $44.8M, vs. its peer group at 19X and as such, we
believe there is opportunity for multiple expansion.
240
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
We believe there are three primary risks to our Overweight rating on Shutterfly:
•
Seasonality: Currently, Shutterfly’s business is very seasonal, with
approximately 50% of revenues earned in the fourth quarter. If the company is
unable to deliver customer orders during the holiday season, there would be
downside risk to our rating.
•
Product pricing: Pricing on 4X6 prints has come down over the last few
years, causing the company to look for growth in other product segments.
Should other product segments experience similar pricing pressure, our
Overweight rating could be at risk.
•
Paper costs: Shutterfly purchases paper from Fuji Film, with whom it also
competes in this space. This contract is up for renewal in September 2007, and
should renewal terms be less favorable than its current contract, the company
could see margin pressure.
241
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 157: SFLY Annual Income Statement
$ in millions, except per share data
FY
2006
FY
2007E
FY
2008E
FY
2009E
Revenues
Product Revenue (80%)
Shipping Revenue (20%)
123.4
98.7
24.7
183.0
146.4
36.6
251.0
200.8
50.2
328.1
262.5
65.6
Cost of revenues
Pro forma adj for SBC
Gross Profit
Pro forma Gross Profit
Gross Margins
55.4
0.1
67.9
67.8
55.1%
82.4
0.1
100.5
100.4
54.9%
112.7
138.2
138.2
55.1%
146.9
181.2
181.2
55.2%
Technology and Development
Sales and Marketing
General and Administrative
Total Operating Expenses
Total SBC adjustments
Total pro forma operating expenses
19.1
21.9
19.2
60.2
2.204
58.0
29.7
31.3
28.9
89.9
3.5
86.4
38.3
44.5
38.0
120.9
2.9
118.0
49.0
56.4
47.6
153.0
4.2
148.8
Income from Operations
PF Income from Operations
Operating Margins
7.7
9.8
6.2%
10.6
14.0
5.8%
17.3
20.2
6.9%
28.1
32.3
8.6%
EBITDA
EBITDA Margins
EBITDA Growth Y/Y
20.7
16.8%
40.6%
31.8
17.4%
53.6%
44.8
17.8%
40.7%
61.5
18.7%
37.3%
Interest Expense
Interest Income
EBT and accounting change
Tax benefit (provision)
Assumed Tax Rate
(0.3)
2.3
9.7
(3.9)
40%
(0.2)
5.8
16.2
(5.9)
37%
(0.2)
6.2
23.3
(8.6)
37%
(0.2)
6.6
34.5
(12.8)
37%
EAT and before accounting change
Cumulative effect of change in acct principle
Net income
5.8
5.8
10.2
10.2
14.7
14.7
21.7
21.7
EPS - basic
EPS - diluted
Adjusted EPS (diluted)
Pro Forma Diluted Sharecount
Shares outstanding - basic
Shares outstanding - diluted
(1.11)
0.56
0.12
20.8
8.6
10.3
0.42
0.38
0.36
28.8
24.3
26.8
0.56
0.53
0.49
29.7
25.3
27.5
0.79
0.75
0.71
30.5
25.6
28.8
Customers
Y/Y Growth
Orders
Y/Y Growth
Average order per customer
Y/Y Growth
Average Order Size
Y/Y Growth
1,734,780
42.3%
5,104,859
39.8%
1.95
-1.4%
$24.16
5.1%
2,329,545
34.3%
6,842,183
34.0%
1.94
-0.7%
$26.74
10.7%
2,987,472
28.2%
8,834,439
29.1%
1.95
0.6%
$28.41
6.2%
3,682,144
23.3%
11,074,806
25.4%
1.98
1.7%
$29.62
4.3%
Source: Company reports and JPMorgan estimates.
242
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 158: SFLY Quarterly Income Statement
$ in millions, except per share data
Q1-06
FY2006
Q2-06
Q3-06
Q4-06
Q1-07
FY2007E
Q2-07
Q3-07
Revenues
Product Revenue (80%)
Shipping Revenue (20%)
Cost of revenues
Pro forma adj for SBC
Gross Profit
Pro forma Gross Profit
Gross Margins
Technology and Development
Sales and Marketing
General and Administrative
Total Operating Expenses
Total SBC adjustments
Total pro forma operating expenses
16.9
13.5
3.4
8.7
0.0
8.1
8.1
48.2%
4.0
3.7
3.4
11.1
0.4
10.7
19.6
15.7
3.9
9.8
0.0
9.9
9.9
50.3%
4.3
4.5
4.3
13.1
0.4
12.6
21.2
16.9
4.2
10.9
0.0
10.3
10.3
48.6%
5.0
5.4
5.1
15.4
0.6
14.8
65.7
52.5
13.1
26.1
0.0
39.6
39.6
60.3%
5.9
8.3
6.5
20.7
0.7
20.0
26.7
21.4
5.3
13.0
0.0
13.7
13.6
51.2%
5.8
5.2
6.0
17.0
0.8
16.1
29.9
23.9
6.0
14.8
0.0
15.0
15.0
50.4%
6.6
7.2
6.7
20.6
0.9
19.7
32.6
26.1
6.5
17.2
0.0
15.4
15.3
47.1%
7.6
7.0
7.4
22.0
1.0
21.0
Income from Operations
PF Income from Operations
Operating Margins
(2.9)
(2.6)
-17.4%
(3.2)
(2.8)
-16.3%
(5.1)
(4.5)
-24.2%
18.9
19.6
28.8%
(3.3)
(2.5)
-12.3%
(5.5)
(4.7)
-18.5%
EBITDA
EBITDA Margins
EBITDA Growth Y/Y
(0.3)
-1.6%
(0.3)
-1.4%
(1.6)
-7.7%
22.9
34.9%
1.1
4.1%
Interest Expense
Interest Income
(0.1)
0.5
(0.1)
0.0
(0.1)
0.5
(0.1)
1.3
EBT and accounting change
Tax benefit (provision)
Assumed Tax Rate
(2.5)
1.0
(3.2)
1.1
(4.7)
1.9
EAT and before accounting change
Cumulative effect of change in acct principle
Net income
(1.6)
(2.1)
(1.6)
EPS - basic
EPS - diluted
Adjusted EPS (diluted)
Pro Forma Dilluted Sharecount
Shares outstanding - basic
Shares outstanding - diluted
(0.41)
(0.41)
(0.09)
17.6
3.8
3.8
FY2008E
Q2-08E
Q3-08E
Q4-07E
Q1-08E
Q4-08E
93.8
75.0
18.8
37.3
36.3
29.0
7.3
18.0
41.6
33.3
8.3
20.6
45.0
36.0
9.0
23.0
128.0
102.4
25.6
51.2
56.5
56.5
60.2%
9.7
11.9
8.8
30.4
0.8
29.6
18.3
18.3
50.5%
8.6
8.3
8.0
24.9
0.6
24.3
21.0
21.0
50.5%
9.2
9.6
9.3
28.0
0.7
27.3
22.1
22.1
49.0%
10.4
11.3
9.9
31.5
0.7
30.8
76.8
76.8
60.0%
10.2
15.4
10.9
36.5
0.9
35.6
(6.6)
(5.7)
-20.3%
26.1
26.9
27.8%
(6.6)
(6.0)
-18.1%
(7.0)
(6.3)
-16.8%
(9.5)
(8.8)
-21.0%
40.3
41.2
31.5%
(0.6)
-2.0%
(0.70)
-2.1%
32.0
34.1%
(0.1)
-0.4%
(0.2)
-0.4%
(2.5)
-5.6%
47.6
37.2%
(0.1)
1.5
(0.0)
1.4
(0.1)
1.4
(0.1)
1.5
(0.1)
1.5
(0.1)
1.5
(0.1)
1.6
(0.1)
1.6
20.2
(8.0)
(1.9)
0.8
(4.2)
1.7
41%
(5.3)
2.0
38%
27.5
(10.5)
38%
(5.1)
1.9
37%
(5.5)
2.1
37%
(7.9)
2.9
37%
41.9
(15.5)
37%
(2.7)
12.2
(1.1)
(2.4)
(3.3)
17.1
(3.2)
(3.5)
(5.0)
26.4
(2.1)
(2.7)
12.2
(1.1)
(2.4)
(3.3)
17.1
(3.2)
(3.5)
(5.0)
26.4
(0.54)
(0.54)
(0.12)
17.7
3.9
3.9
(0.70)
(0.70)
(0.15)
17.8
4.0
4.0
0.53
0.50
0.49
25.1
22.8
24.5
(0.04)
(0.04)
(0.04)
23.9
23.9
23.9
(0.10)
(0.10)
(0.10)
24.1
24.1
24.1
(0.14)
(0.14)
(0.14)
24.5
24.5
24.5
0.70
0.64
0.64
26.8
24.5
26.8
(0.13)
(0.13)
(0.13)
24.8
24.8
24.8
(0.14)
(0.14)
(0.14)
25.1
25.1
25.1
(0.20)
(0.20)
(0.20)
25.4
25.4
25.4
1.03
0.96
0.96
27.5
25.7
27.5
Source: Company reports and JPMorgan estimates.
243
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 159: SFLY Quarterly Income Statement
$ in millions, except per share data
Q1-06
Q2-06
523,896
40.6%
980,798
33.7%
1.87
-4.9%
$17.21
-4.1%
517,518
35.5%
1,041,129
33.9%
2.01
-1.2%
$18.86
3.9%
62%
38%
10.5
6.4
Expenses as % of Revenue
Cost of revenues
Technology and Development
Sales and Marketing
General and Administrative
Y/Y Change
Revenue Growth
Cost of revenues
Technology and Development
Sales and Marketing
General and Administrative
FY2006
Q3-06
Q4-06
Q1-07
Q2-07
623,000
39.6%
1,244,000
42.5%
2.00
2.1%
$17.00
-5.2%
955,104
47.4%
1,838,932
45.3%
1.93
-1.5%
$35.72
10.2%
693,092
32.3%
1,288,471
31.4%
1.86
-0.7%
$20.73
20.5%
58%
42%
11.4
8.2
61%
39%
12.9
8.3
40%
60%
26.1
39.5
51.8%
23.6%
21.9%
20.1%
49.7%
21.7%
22.9%
21.9%
51.4%
23.4%
25.5%
23.9%
28%
36%
72%
62%
21%
39%
43%
55%
56%
81%
Sequential Change
Revenue Growth
-58.8%
Cost of revenues
Technology and Development
Sales and Marketing
General and Administrative
-48.2%
-9.0%
-41.8%
-40.0%
Customers
Y/Y Growth
Orders
Y/Y Growth
Average order per customer
Y/Y Growth
Average Order Size
Y/Y Growth
Print Revenue (% of total revenue)
Non-Print Revenue (% of total revenue)
Print Revenue
Non-print revenue
Source: Company reports and JPMorgan estimates.
244
FY2007E
FY2008E
Q2-08E
Q3-08E
Q3-07
Q4-07E
Q1-08E
Q4-08E
731,384
41.3%
1,461,804
40.4%
2.00
-0.7%
$20.44
8.4%
844,400
35.5%
1,660,840
33.5%
1.97
-1.5%
$19.63
15.5%
1,260,737
32.0%
2,431,068
32.2%
1.93
0.2%
$38.58
8.0%
901,020
30.0%
1,675,012
30.0%
1.86
0.0%
$21.66
4.5%
943,485
29.0%
1,885,727
29.0%
2.00
0.0%
$22.08
8.0%
1,080,832
28.0%
2,142,484
29.0%
1.98
0.8%
$21.00
7.0%
1,601,136
27.0%
3,131,216
28.8%
1.96
1.4%
$40.89
6.0%
51%
49%
13.6
13.1
48%
52%
14.3
15.5
51%
49%
16.6
16.0
30%
70%
28.1
65.6
45%
55%
16.3
20.0
43%
57%
17.9
23.7
45%
55%
20.3
24.8
26%
74%
33.3
94.8
39.7%
8.9%
12.7%
9.8%
48.8%
21.8%
19.4%
22.3%
49.9%
22.2%
24.1%
22.6%
51.1%
23.2%
21.6%
22.6%
39.8%
10.3%
12.7%
9.4%
49.5%
23.6%
23.0%
22.0%
49.5%
22.0%
23.0%
22.3%
51.0%
23.0%
25.0%
22.0%
40.0%
8.0%
12.0%
8.5%
36%
60%
34%
44%
80%
60%
54%
34%
32%
14%
58%
49%
46%
40%
76%
52%
52%
55%
60%
57%
54%
59%
53%
30%
45%
43%
43%
64%
43%
36%
36%
38%
47%
61%
34%
39%
39%
38%
33%
38%
38%
33%
37%
60%
35%
37%
37%
6%
29%
23%
16.3%
7.7%
210.5%
-59.3%
11.9%
9.1%
187.7%
-61.3%
14.7%
8.1%
184.5%
11.5%
7.2%
22.0%
26.6%
11.4%
16.1%
19.9%
17.6%
139.9%
18.5%
54.6%
27.8%
-50.0%
-1.0%
-37.9%
-7.7%
13.8%
14.2%
39.0%
13.0%
16.2%
14.1%
-2.2%
9.1%
116.5%
27.5%
69.1%
19.9%
-51.9%
-11.4%
-29.9%
-9.4%
14.7%
6.9%
14.7%
16.3%
11.4%
13.0%
17.5%
6.6%
123.2%
-1.0%
36.6%
9.9%
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 160: SFLY Annual Balance Sheet
$ in millions
FY
2006
FY
2007E
FY
2008E
FY
2009E
ASSETS
Cash and cash equivalents
Short-term investments
Accounts receivable
Net inventory
Deferred tax asset - current
Other current
Total current assets
119.1
2.2
2.5
2.1
2.8
128.6
107.0
3.0
2.8
2.8
1.7
3.7
121.0
115.9
3.0
3.8
3.8
1.7
3.7
132.1
134.5
3.0
5.0
5.0
1.7
3.7
152.9
Net fixed assets
Acquisition cost
Intangible assets, net
Deferred tax asset
Other assets
Total assets
30.9
1.4
18.8
0.5
180.2
48.5
3.9
23.7
2.2
199.3
58.5
3.9
23.7
2.2
220.3
69.3
3.9
23.7
2.2
251.9
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable
Accrued liabilities
Litigation settlement
Deferred revenue
Lease obligation - current
Note payable - current
Total Current Liabilities
9.4
8.8
6.3
2.0
26.4
8.4
11.3
8.4
1.3
29.5
10.2
14.1
9.0
1.3
34.6
12.5
16.6
11.6
1.3
42.0
Lease obligations
Other liabilities
Note payable
Litigation settlement
Preferred stock warrant liability
Total Liabilities
1.7
0.7
28.8
1.0
0.5
31.0
1.0
0.5
36.2
1.0
0.5
43.6
Series A-F preferred stock
Common stock at par
Additional paid in capital
Accumulated other comprehensive income
Deferred stock-based comp
Retained earnings
Total stockholder equity
0.0
182.0
188.3
189.5
(0.2)
(30.3)
151.4
180.2
(20.1)
168.2
199.3
(5.4)
184.1
220.3
192.0
16.3
208.3
251.9
Total Liabilities and shareholders equity
Source: Company reports and JPMorgan estimates.
245
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 161: SFLY Annual Statement of Cash Flows
$ in millions
OPERATING ACTIVITIES:
Net income (loss)
Depreciation and amortization
Amortization of intangible assets
Amortization of stock-based compensation, net of cancellation
Amortization of warrants
Change in carrying value of preferred stock warrant liability
Gain/loss on disposal of fixed assets
Deferred income taxes
Charitable contribution expense for shares issued to charitable foundation
Changes in operating assets and liabilities:
Inventories
Accounts receivable
Prepaid expenses & other current assets
Deferred tax asset
Other assets
Accounts payable
Accrued liabilities
Preferred stock warrant liability
Deferred revenue
Deferred rent
Net cash provided by operating activities
FCF
INVESTING ACTIVITIES:
Purchase of property & equipment
Cash acquired from acquisition of business
Proceeds from sale of property and equipment
Net cash provided by (used in) investing activities
FINANCING ACTIVITIES:
Principal payments of capital lease obligation
Proceeds from loan from a related party
Repayment of loan from a related party
Proceeds from loan
Repayment of loan
Principal payment of note payable obligation
Proceeds from issuance of redeemable conv. pref stock, net of issuance cost
Payment of IPO related costs
Proceeds from issuance of common stock
Proceeds from exercise of unvested options
Other
Repurchase of common stock
Net cash provided by (used in) financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Source: Company reports and JPMorgan estimates.
246
FY
2006
FY
2007E
FY
2008E
FY
2009E
5.8
10.6
0.2
2.3
(0.2)
10.2
17.2
0.4
3.6
-
14.7
24.0
0.6
2.9
-
(0.0)
3.2
0.2
(4.5)
-
(0.5)
(1.4)
(1.2)
(1.2)
(0.1)
5.5
(3.8)
1.7
22.3
0.4
(0.3)
(0.6)
(0.9)
(1.7)
(0.9)
2.8
2.2
27.5
3.1
(1.0)
(1.0)
1.8
2.8
0.5
45.2
21.7
28.6
0.6
4.2
5.1
(1.1)
(1.1)
2.2
2.5
2.7
60.2
1.6
(7.4)
11.2
20.8
(20.7)
(34.9)
(34.0)
(39.4)
(20.7)
(1.3)
-
(3.0)
(40.6)
(2.4)
-
(34.0)
(2.3)
-
-
3.4
-
80.2
-
-
-
(0.0)
78.3
1.0
(2.3)
(39.4)
(2.3)
(2.3)
79.9
39.2
119.1
(12.1)
119.1
107.0
9.0
107.0
115.9
18.6
115.9
134.5
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
ValueClick, Overweight ($23.39)
We are maintaining our Overweight rating on VCLK. We believe that 2008
prospects for growth look good given rising online advertising trends. We also see
meaningful margin expansion opportunities in 2008 from the acquisition of
MeziMedia. Finally, we think that the Street overreacted to the promotional lead-gen
investigation given settlement agreements of comparable investigations. VCLK is
trading at an EV/EBITDA multiple of 11.0x our F'08 EBITDA estimate vs. the peer
group average of 14.4x, as such, we rate the stock Overweight.
• MeziMedia will likely boost top- and bottom-line growth. We expect
MeziMedia to grow 59% Y/Y organically in 2008, bringing total comparison
shopping growth to 109% Y/Y. Furthermore, we believe that the SEO
technology of MeziMedia is a strong margin driver that can also be leveraged by
the Pricerunner platform. Thus, we are modeling EBITDA margins expanding 20
bps Y/Y in F’08.
• Upside to lead gen estimates possible. Since the announcement of the
promotional lead-gen investigation, Adteractive, a close promotional lead-gen
competitor, settled its FTC investigation with a $650,000 fine and an agreement
to conspicuously disclose payments or obligations of consumers to obtain gifts
and prizes. Although we are still modeling F'08 promotional lead-gen revenues
disappearing to be conservative, we think that there may be upside to this
estimate if the FTC allows the business to continue with disclosures.
• 2008 Drivers. In our view, the following factors will drive VCLK shares in
2008: (1) settlement of the FTC investigation, (2) leverage of MeziMedia
technology by other business lines, and (3) affiliate marketing strength from
increased online ad spend and market share gains.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $176.3M, $44.0M, and $0.18 (Y/Y growth of 10%, (5%), and
(14%) respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 162: ValueClick Financial Snapshot
$ in millions, except per share data
ValueClick
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
176.25
44.00
0.18
638.75
163.80
0.71
735.00
189.65
0.84
858.97
220.26
1.01
17.1%
13.0%
15.4%
15.1%
15.8%
18.9%
16.9%
16.1%
19.8%
175.98
43.68
0.18
639.25
164.10
0.71
740.77
191.31
0.82
856.30
227.09
1.06
15.9%
16.6%
15.5%
15.6%
18.7%
29.3%
Source: JPMorgan estimates, Company data, and Bloomberg
247
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We are revising our F’08 revenue estimate to $735M and our full-year EPS estimate
to $0.84 (from $731M and $0.83), representing Y/Y revenue and EPS growth of 15%
and 19%, respectively.
We expect the media segment to contribute $352M of revenue, representing an 8%
Y/Y decline in growth. We believe that lead-gen losses will drive down growth
levels until the losses begin to be comped in 2Q’08. However, we are very
tentatively optimistic that there may be upside to our modeled losses if the FTC
settlement allows for the continuation of the business with disclosures. We expect
the display advertising business to remain strong as money shifts from lead-gen to
display and as dollars shift to the online graphical ad market.
We expect comparison shopping to contribute $187M of revenue, representing 109%
Y/Y growth. Much of this growth, we believe, will be driven by the MeziMedia
acquisition, which we see growing ~59% organically Y/Y. Furthermore, we believe
that the SEO technology of MeziMedia is a strong margin driver that can also be
leveraged by the Pricerunner platform. Thus, we are modeling EBITDA margins
expanding 20 bps Y/Y in F’08.
We see affiliate marketing achieving revenues of $162M, representing 18% Y/Y
growth, a very modest deceleration from F’07E’s 22% Y/Y growth. We believe that
this segment will continue to benefit from shifts towards online spending and will
continue to gain market share as the leading affiliate network.
We believe that the technology segment will experience 13% Y/Y growth, yielding
revenues of $36.8M, a significant deceleration from F’07E’s 26% Y/Y growth. We
believe that growth will be hindered by increased competition from MSN due to its
recent acquisition of aQuantive and Google with its planned DoubleClick
acquisition.
Our Estimates and Outlook for 2009
We are introducing F’09 revenue and EPS estimates of $859M and $1.01, which
represent 17% and 20% Y/Y growth, respectively. While revenue is effectively in
line with consensus of $856M, our EPS estimate is lower than consensus of $1.06 as
we believe that shifts to display advertisements from lead-gen business and increased
pricing pressure from competition will begin to offset margin gains from MeziMedia.
We are modeling a 20 bp Y/Y decline in EBITDA margin.
We believe that much of the growth will be driven by international revenue across all
segments and that domestic growth will be supported by further shifts toward online
advertising and the demand for increased customer targeting and rich media services.
However, we believe that competition will intensify as large, capital-rich Internet
companies are attracted to the growing market.
Valuation and Rating Analysis
On an EV/EBITDA basis, ValueClick trades at 11.0x our F' 08 EBITDA estimate of
$189.6M, vs. its peers which trade at 14.4x. We believe that the market has overreacted to the announced FTC investigation and market conditions. Hence, our
Overweight rating.
248
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
ValueClick shares may underperform other companies in our coverage universe if 1)
the online advertising market weakens and advertisers limit their expenditures to toptier properties/networks, such as Google, Yahoo! and MSN, 2) the company loses
share to large online networks, such as Google, Yahoo and MSN, or if smaller online
advertising players create stronger offerings, 3) the company is unable to increase its
presence in international markets, including Europe and China and 4) if FTC
investigations have a larger-than-projected impact on growth.
249
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 163: VCLK Annual Income Statement
$ in millions, except per share data
FY 2006
F2007E
F2008E
F2009E
Revenues
Media
Comparison Shopping
Affiliate Marketing
Technology
Intercompany eliminations and others
545.6
383.0
26.2
112.2
25.7
(1.4)
638.7
381.4
89.5
137.2
32.5
(1.8)
735.0
352.0
186.7
161.5
36.8
(1.9)
859.0
403.6
232.1
185.7
39.5
(1.9)
Cost of Revenues
Media
Comparison Shopping
Affiliate Marketing
Technology
Intercompany eliminations and others
167.9
141.5
2.2
19.8
5.4
(0.9)
202.8
149.8
21.3
27.8
5.7
(1.8)
239.6
155.0
46.7
32.7
6.4
(1.2)
281.3
177.7
58.0
39.5
7.3
(1.2)
Gross Profit
Media Gross Margin
Comparison Shopping Gross Margin
Affiliate Marketing Gross Margin
Technology Gross Margin
Gross Profit Margin
377.8
63.1%
91.7%
82.4%
79.0%
69%
435.9
60.7%
76.2%
79.7%
82.4%
68.2%
495.4
56.0%
75.0%
79.7%
82.6%
67.4%
577.7
56.0%
75.0%
78.7%
81.6%
67.3%
Operating Cost
Sales and marketing
General and administrative
Product development
Stock-based compensation
Amortization of intangibles and acquired software
Merger Related Costs
Restructuring Charges
275.6
158.5
52.9
30.5
11.9
21.8
0.0
0.0
324.8
185.5
62.8
33.4
18.2
25.0
0.0
0.0
332.1
207.9
73.5
36.7
20.0
21.2
0.0
0.0
412.6
249.1
75.1
47.2
20.0
21.2
0.0
0.0
Income (loss) from operations
Operating Margin
102.1
18.7%
111.1
17.4%
136.0
18.5%
165.1
19.2%
0.0
8.0
0.0
0.0
0.0
11.8
0.0
0.0
0.0
12.0
0.0
0.0
0.0
14.0
0.0
0.0
Income (loss) before income taxes and minority interest
110.1
122.8
148.0
179.1
Provision for income taxes
Tax Rate
47.6
43.2%
51.3
41.8%
63.7
43.0%
77.9
43.5%
Income (loss) before minority interest
62.6
71.5
84.4
101.1
Minority interest in ValueClick Japan
0.0
0.0
0.0
0.0
Net income (loss)
FASB 123 Adjustment
Net Income Adjusted for FASB123
62.6
62.6
71.5
71.5
84.4
84.4
101.1
101.1
EPS (Diluted) - Ex FAS 123R
EPS (Diluted) w/ FAS 123R
0.73
0.62
0.89
0.71
1.04
0.84
1.21
1.01
Equity in loss of ValueClick Japan
Interest income, net
Gain on the sale of ValueClick Japan stock
Other Income
Source: Company reports and JPMorgan estimates.
250
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 164: VCLK Quarterly Income Statement
$ in millions, except per share data
1Q 2006
2Q 2006
3Q 2006
4Q 2006
1Q 2007
2Q 2007
3Q 2007
4Q 2007E
1Q 2008E
2Q 2008E
3Q 2008E
4Q 2008E
Revenues
Media
Comparison Shopping
Affiliate Marketing
Technology
Intercompany eliminations and others
117.3
79.4
5.5
26.9
5.8
(0.3)
130.0
93.5
5.9
25.2
5.7
(0.4)
137.9
98.4
5.9
27.4
6.5
(0.3)
160.4
111.6
8.8
32.7
7.7
(0.5)
156.9
108.4
8.6
32.8
7.5
(0.4)
148.7
100.9
8.2
32.3
7.8
(0.5)
156.9
85.6
29.4
34.1
8.2
(0.5)
176.3
86.4
43.3
38.0
9.1
(0.5)
176.4
86.5
43.3
38.7
8.4
(0.5)
175.3
89.1
39.8
38.1
8.8
(0.5)
173.1
82.2
41.9
40.3
9.3
(0.5)
210.2
94.3
61.7
44.4
10.2
(0.5)
Cost of Revenues
Media
Comparison Shopping
Affiliate Marketing
Technology
Intercompany eliminations and others
39.2
33.7
0.3
4.1
1.3
(0.2)
42.1
36.2
0.5
4.3
1.3
(0.2)
38.7
31.7
0.5
5.3
1.4
(0.2)
47.8
39.8
0.9
6.0
1.4
(0.3)
47.0
38.5
1.3
6.0
1.5
(0.2)
49.1
39.9
1.8
6.7
1.4
(0.8)
50.5
35.1
7.3
7.2
1.4
(0.5)
56.2
36.3
10.8
8.0
1.5
(0.3)
56.3
37.2
10.8
7.0
1.6
(0.3)
58.4
39.2
10.0
8.0
1.6
(0.3)
56.4
36.2
10.5
8.5
1.6
(0.3)
68.5
42.4
15.4
9.3
1.6
(0.3)
Gross Profit
Media Gross Margin
Comparison Shopping Gross Margin
Affiliate Marketing Gross Margin
Technology Gross Margin
Gross Profit Margin
78.1
57.5%
94.7%
84.7%
77.1%
67%
87.9
61.3%
92.3%
82.8%
76.9%
68%
99.2
67.8%
91.3%
80.7%
78.9%
72%
112.6
64.4%
89.8%
81.5%
82.1%
70%
109.9
64.5%
84.3%
81.8%
80.6%
70%
99.6
60.5%
77.8%
79.2%
81.5%
67%
106.4
59.0%
75.2%
78.9%
83.0%
68%
120.0
58.0%
75.0%
79.0%
84.0%
68%
120.2
57.0%
75.0%
82.0%
81.0%
68%
116.8
56.0%
75.0%
79.0%
82.0%
67%
116.8
56.0%
75.0%
79.0%
83.0%
67%
141.7
55.0%
75.0%
79.0%
84.0%
67%
61.9
30.1
15.5
7.4
3.3
5.7
-
62.7
36.5
10.0
7.6
3.2
5.5
-
74.4
45.1
13.1
7.7
3.0
5.5
-
76.6
46.8
14.4
7.8
2.4
5.2
-
80.7
47.4
15.5
8.4
3.6
5.8
-
73.6
40.9
14.2
8.1
4.9
5.5
-
80.1
45.2
15.5
8.1
4.6
6.7
-
90.4
52.0
17.6
8.8
5.0
7.0
-
87.9
51.2
17.6
8.8
5.0
5.3
-
83.9
47.3
17.5
8.8
5.0
5.3
-
84.7
48.5
17.3
8.7
5.0
5.3
-
102.8
61.0
21.0
10.5
5.0
5.3
-
16.14
13.8%
25.2
19.4%
24.8
18.0%
36.0
22.4%
29.2
18.6%
26.0
17.5%
26.3
16.8%
29.6
16.8%
32.2
18.3%
32.9
18.8%
32.0
18.5%
38.9
18.5%
1.9
2.0
1.6
2.4
2.9
3.4
2.9
2.5
3.0
3.0
3.0
3.0
18.1
27.2
26.4
38.5
32.1
29.4
29.2
32.1
35.2
35.9
35.0
41.9
8.3
45.8%
12.7
46.8%
9.6
36.5%
16.9
44.0%
13.5
42.0%
11.8
40.1%
12.4
42.5%
13.6
42.5%
15.1
43.0%
15.4
43.0%
15.1
43.0%
18.0
43.0%
Operating Cost
Sales and marketing
General and administrative
Product development
Stock-based compensation
Amortization of intangibles and acquired software
Merger Related Costs
Restructuring Charges
Income (loss) from operations
Operating Margin
Equity in loss of ValueClick Japan
Interest income, net
Gain on the sale of ValueClick Japan stock
Other Income
Income (loss) before income taxes and
minority interest
Provision for income taxes
Tax Rate
251
Imran Khan
(1-212) 622-6693
[email protected]
Income (loss) before minority interest
North America Equity Research
02 January 2008
1Q 2006
2Q 2006
3Q 2006
4Q 2006
1Q 2007
2Q 2007
3Q 2007
4Q 2007E
1Q 2008E
2Q 2008E
3Q 2008E
4Q 2008E
9.8
14.4
16.8
21.6
18.6
17.6
16.8
18.4
20.1
20.5
20.0
23.9
9.8
16.8
16.8
21.6
21.6
18.6
18.6
17.6
17.6
16.8
16.8
18.4
18.4
20.1
20.1
20.5
20.5
20.0
20.0
23.9
23.9
0.20
0.17
0.24
0.22
0.22
0.18
0.22
0.17
0.21
0.17
0.23
0.18
0.25
0.20
0.25
0.20
0.25
0.20
0.29
0.24
Minority interest in ValueClick Japan
Net income (loss)
FASB 123 Adjustment
Net Income Adjusted for FASB123
9.8
14.4
14.4
EPS (Diluted) - Ex FAS 123R
EPS (Diluted) w/ FAS 123R
0.13
0.09
0.17
0.14
Source: Company reports and JPMorgan estimates.
252
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 165: VCLK Annual Balance Sheet
$ in millions
FY 2006
FY 2007E
FY 2008E
FY 2009E
Cash and cash equivalents
Investment in marketable securities, at market value
Pledged marketable securites, at fair value
Accounts receivable, net
Inventories
Prepaid expenses and other current assets
Deferred tax assets
IPO proceeds receivable
Income taxes receivable
Total Current Assets
76.8
204.8
107.8
2.6
4.3
6.6
403.0
151.1
188.4
111.8
1.6
9.0
461.9
301.9
192.2
111.8
1.6
9.0
616.5
482.6
196.1
111.8
1.6
9.0
801.1
Property and equipment, net
Marketable Securities, at fair value
Intangibles, net
Goodwill
Deferred income taxes
Other assets
19.0
0.0
91.4
278.1
0.5
1.4
18.0
4.0
63.9
273.0
0.0
1.5
19.6
4.0
63.9
273.0
0.0
1.5
22.4
4.0
63.9
273.0
0.0
1.5
Total Assets
793.3
822.3
978.5
1165.9
Accounts payable and accrued expenses
Income taxes payable
Deferred revenue
Short-term debt
Other current liabilities
Total current liabilities
83.8
2.5
1.1
0.0
0.0
87.4
54.0
3.2
0.5
0.0
0.2
58.0
54.0
3.2
0.5
0.0
0.2
58.0
54.0
3.2
0.5
0.0
0.2
58.0
Capital lease obligation, less current portions
Income taxes payable, less current portion
Deferred Tax Liabilities
Other non-current long-term liabilities
0.0
44.5
14.4
3.3
0.1
0.1
0.1
Total Liabilities
149.6
2.9
1.2
0.0
62.2
2.9
1.2
0.0
62.2
2.9
1.2
0.0
62.2
Minority Interest In Valueclick Japan
Preferred stock
Common stock
Additional paid-in capital
Treasury stock, at cost
Deferred stock compensation
Retained Earnings/Accumulated deficit
Accumulated other comprehensive loss
Total stockholders' equity
0.0
0.0
0.1
632.9
0.0
0.0
5.5
5.2
643.7
0.0
0.0
0.1
630.0
0.0
3.8
127.5
2.7
760.1
0.0
0.0
0.1
630.0
0.0
0.0
283.4
3.0
916.3
0.0
0.0
0.1
630.0
0.0
0.0
470.8
3.0
1103.7
Total Liabilities and Stockholders' Equity
793.3
822.3
978.5
1165.9
Source: Company reports and JPMorgan estimates.
253
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 166: VCLK Annual Cash Flow Statement
$ in millions
FY 2006
FY 2007E
FY 2008E
FY 2009E
62.6
31.1
0.0
0.0
4.8
0.0
10.4
(0.1)
0.0
0.0
0.0
(5.7)
11.1
0.0
0.0
0.0
0.0
0.0
0.0
71.5
32.0
0.0
0.0
1.1
0.0
17.9
7.0
0.0
0.0
0.0
(5.1)
24.5
0.0
0.0
0.0
0.0
0.0
0.0
84.4
33.6
0.0
0.0
0.8
0.0
20.0
10.4
0.0
0.0
0.0
1.6
0.0
0.0
0.0
0.0
0.0
0.0
0.0
101.1
35.2
0.0
0.0
0.8
0.0
20.0
16.0
0.0
0.0
0.0
1.6
0.0
0.0
0.0
0.0
0.0
0.0
0.0
114.2
148.9
150.8
174.7
FCF
104.0
138.5
138.8
160.7
Cash flows from investing activities:
Proceeds from the sale of marketable securities
Purchase of marketable debt securities
Purchase of equity securities
Acquistion of businesses, net of cash acquired
Purchases of property and equipment
Sale of equity interest in Japan subsidiary
Purchases of intangible assets
228.8
(238.9)
0.0
(12.1)
(10.2)
0.0
0.0
114.5
(192.8)
0.0
0.0
(10.4)
0.0
(1.9)
0.0
0.0
0.0
0.0
(12.0)
0.0
0.0
0.0
0.0
0.0
0.0
(14.0)
0.0
0.0
(32.5)
(90.6)
(12.0)
(14.0)
(103.4)
(0.2)
49.0
0.0
0.0
0.0
15.3
0.0
0.0
0.0
12.0
0.0
0.0
0.0
20.0
0.0
(54.6)
15.3
12.0
20.0
Effect of currency translations
2.8
0.6
0.0
0.0
Net increase in cash and cash equivalents
29.9
74.3
150.8
180.7
46.9
76.8
76.8
151.1
151.1
301.9
301.9
482.6
Net Income
Depreciation and amortization
Cumulative effect of change in accounting principal
Restructuring charge (reversal)
Provision for doubtful accounts
Inventory write-down
Stock-based compensation
Tax benefit from stock option exercises
Gain (loss) on sale of marketable securities
Minority interest in ValueClick Japan
Gain on ValueClick Japan stock issuance
Provision (benefit from) for deferred taxes
Changes in operating assets and liabilities:
Accounts receivable
Prepaid expenses and other assets
Accounts payable and accrued liabilities
Income tax receivable/payable
Deferred revenue
Other non-current liablities
Net cash from operating activities
Net cash used in investing activities
Cash flows from financing activities:
Purchase of Treasury Stock
Repayments on notes payable and capital leases
Net proceeds from exercises of options and warrants
Proceeds from short-term debt, net of payments of capital lease
Net cash provided by financing activities
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Source: Company reports and JPMorgan estimates.
254
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Yahoo!, Overweight ($23.96)
In 2008, we expect Yahoo!’s growth to be driven by the Owned and Operated
business, led by monetization improvements in both search and graphical advertising.
While we think organic network revenues will continue to decline, we see total
network revenue bolstered by newspaper partnerships and the Blue Lithium
acquisition. As such, we maintain our Overweight rating.
• Graphical advertising is poised for a turnaround. We believe that graphical
advertising monetization will improve with use of behavioral targeting and ad
exchanges. Furthermore, YHOO will face easing comps in 2008 with 2007E’s
Y/Y growth of only 19.6% (down from 36% in 2006). As such, we are modeling
18% Y/Y growth for F’08.
• We think that O&O search will grow 29% Y/Y in F’08. Since the company
will not fully start to comp Project Panama's rollout until the second half of the
year, we are modeling 36% Y/Y growth in 1H’08 due to expected monetization
gains. Additionally, we think that the rollout of Project Panama in the int’l
market will be a strong growth driver. As such, we are still modeling ~23% Y/Y
growth due to increased paid click volume and higher CPCs.
• We expect partnerships to ramp in F’08. In F’07, Yahoo! entered into a
number of strategic partnerships, including the newspaper consortium, Bebo,
WebMD, and Cars.com. We believe that Yahoo! will focus on monetizing these
relationships, which we estimate could add ~$100M to F’08 network revenue.
• 2008 Drivers. In our view, the following factors will drive YHOO shares in
2008: (1) continued search monetization increases from Project Panama, (2)
leverage of the Right Media exchange and behavioral targeting to increase
graphical ad monetization, and (3) monetization of partnership agreements.
• Maintaining 4Q'07 estimates. We maintain our 4Q’07 revenue, EBITDA, and
EPS estimates of $1.39B, $506.4M, and $0.11 (Y/Y growth of 13%, (6%), and
(44%), respectively).
Our current and newly introduced 2009 estimates are in the table below:
Table 167: YHOO Estimates Snapshot
$ in millions, except per share data
Yahoo!
JPMorgan
Revenue
EBITDA
EPS
Consensus
Revenue
EBITDA
EPS
4Q'07E
F'07E
F'08E
F'09E
F'07E Y/Y
F'08E Y/Y
F'09E Y/Y
1,385.71
506.37
0.11
5,095.15
1,906.34
0.43
5,894.51
2,248.29
0.49
6,433.21
2,533.17
0.58
11.7%
0.0%
-17.2%
15.7%
17.9%
13.3%
9.1%
12.7%
20.4%
1,408.18
524.62
0.11
5,117.69
1,922.14
0.44
5,953.57
2,273.54
0.54
6,719.19
2,671.11
0.69
16.3%
18.3%
21.6%
12.9%
17.5%
28.0%
Source: JPMorgan estimates, company data, and Bloomberg
255
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We are maintaining our F’08 revenue and GAAP EPS estimates of $5.89B and
$0.49, which represent Y/Y growth of 16% and 13%, respectively.
In 2008, we are expecting a turnaround of the graphical advertising segments, which
we believe will play out via improved CPM growth and demand. We believe that
blended CPM growth will track close to mid-single digits as behavioral targeting and
ad exchanges better monetize the channel. Furthermore, we see increased demand
for the advertising form as presidential campaign volume and the writers strike drive
marketing dollars from TV to display advertising. As such, we are modeling
graphical advertising Y/Y growth of 18% to $2.0B.
We believe that Yahoo! will continue to benefit materially through higher search
monetization as a result of Project Panama. The company began to roll out the new
search platform in 1Q'07, with much of the international rollout occurring during
2H'07. Thus, we think that O&O search growth rates will accelerate to 29% Y/Y
from 27% in F'07E.
Another key component of Yahoo!’s 2008 performance will be its ability to monetize
its graphical affiliate partnerships. In 2007, Yahoo! was able to sign numerous
partnerships, including the newspaper consortium, Bebo, Cars.com, and WebMD. In
2008, we look for the company to begin to generate revenue from these relationships,
which we think can approach ~$100M.
256
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 168: Yahoo! Partnership Estimates
$ in millions
Company
Category
Partership
Date
Ave. Monthly
Unique Users
(TTM)
PV (last 12
Months
through Nov.)
Bebo
Comcast
Social Network
Cable,
entertainment
Newspapers
9/12/2007
4/30/2007
3.6
20.7
28,469
39,890
Estimated
Incremental
YHOO
Revenue
5.6
31.9
4/16/2007
6.5
1,524
1.2
Newspapers
4/16/2007
NA
NA
NA
Newspapers
4/16/2007
2.0
298
0.2
Newspapers
4/16/2007
NA
NA
NA
Newspapers
4/16/2007
NA
NA
NA
Newspapers
Newspapers
11/20/2006
11/20/2006
4.4
3.4
1,057
1,088
0.8
0.9
Newspapers
11/20/2006
16.7
5,049
4.0
Newspapers
11/20/2006
6.4
105
0.1
Newspapers
11/20/2006
1.1
110
0.1
Newspapers
Newspapers
11/20/2006
11/20/2006
5.3
3.5
1,137
624
0.9
0.5
Online auctions
site
5/25/2006
80.2
112,806
53.6
The McClatchy
Company
Calkins Media,
Inc.
Media General,
Inc.
Morris
Communication
s, Inc.
Paddock
Publications,
Inc.
Belo Corp
Cox
Newspapers
The E.W.
Scripps
Company
Hearst
Newspapers
Journal Register
Company
Lee Enterprises
MediaNews
Group, Inc.
eBay
Total
99.9
Source: comScore and JPMorgan estimates
Our Estimates and Outlook for 2009
We are introducing 2009 revenue, EBITDA, and EPS estimates of $6.43B, $2.53B,
and $0.58. Our newly introduced F’09 revenue, EBITDA, and EPS estimates call for
Y/Y growth of 9%, 13%, and 20%, respectively.
We expect roughly sustained graphical advertising growth of 17% Y/Y as we believe
targeting capabilities will drive both monetization and demands. We expect O&O
search growth to decline to the high teens from the high twenties as the company
monetizes its gains and as we believe that it will continue to lose market share to
Google. Finally, we think network revenue will decline 3% as the company focuses
on it O&O businesses.
Valuation and Rating Analysis
Given our belief that the company has begun to address softness in the graphical
advertising market, that there is further upside potential to Project Panama than
currently expected, and that asset value limits downside, we rate the stock
Overweight. On an EV/EBITDA basis, Yahoo! trades at 11.4x our F’08 EBITDA
estimate of $2.25B vs. its peers at 18.0x F’08 estimates.
257
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating
Yahoo! is heavily dependent on the performance of the online advertising industry.
Yahoo! generates the majority of its net revenues from its Marketing Services
revenue unit. The advertising industry is susceptible to overarching economic
conditions, making a large portion of Yahoo!’s revenues vulnerable to general
economic risk. Changes in competition (e.g., mergers/acquisitions) and new
regulations could also impact Yahoo!’s main revenue stream.
258
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 169: YHOO Annual Income Statement
$ in millions, except per share data
FY-06
3,761.3
798.5
FY-07E
4,231.1
864.0
FY-08E
4,993.1
901.4
FY-09E
5,681.2
752.0
4,559.8
5,095.2
5,894.5
6,433.2
804.9
975.1
1,165.9
1,288.6
Gross Profit
Gross Margin
3,754.9
82.3%
4,120.1
80.9%
4,728.6
80.2%
5,144.6
80.0%
Sales and Marketing
Product Development
G&A
Amortization & stock comp
FAS123 Adjustment
Other Adjustment
Total Expenses
Total Expenses (ex-FAS123R)
1,167.2
688.3
410.4
124.8
423.3
2,814.0
2,390.7
1,342.5
873.4
532.0
117.3
589.3
3,454.5
2,865.2
1,461.7
1,014.1
681.4
123.0
765.0
4,045.3
3,280.3
1,579.9
1,087.7
730.9
123.0
780.0
4,301.5
3,521.5
Operating Profit
Operating Margin (Reported)
940.9
20.6%
665.5
13.1%
683.3
11.6%
843.2
13.1%
EBITDA
EBITDA Margin
Interest Income
Investment gains (losses)
Contract termination fees
Other
Other income, net
1,905.9
41.8%
157.0
1,906.3
37.4%
144.9
2,248.3
38.1%
2,533.2
39.4%
160.0
160.0
IBT & Minority Interest
Margins
1,098.0
24%
810.5
16%
843.3
14%
1,003.2
16%
Income Taxes
Tax Rate
458.0
42%
343.2
42%
354.2
42%
421.3
42%
IAT
Earnings in Equity Interest
Minority Interest
IAT & Minority Interest
639.9
112.1
(0.7)
751.3
467.3
132.8
1.1
601.2
489.1
175.0
664.1
581.8
210.0
791.8
-
-
-
-
Reported Net Income
Reported EPS GAAP (inc. FAS 123R)
751.3
0.52
601.2
0.43
664.1
0.49
791.8
0.58
Diluted Shares
1,492
1,403
1,370
1,355
% of Total Revenue
Marketing Services
Fees
Sales and Marketing
Product Development
G&A
82%
18%
26%
15%
9%
83%
17%
26%
17%
10%
85%
15%
25%
17%
12%
88%
12%
25%
17%
11%
Y/Y Change
Marketing Services
Fees
Revenue
Sales and Marketing
Product Development
G&A
24%
20%
23%
26%
26%
28%
12%
8%
12%
27%
27%
30%
18%
4%
16%
16%
16%
28%
14%
-17%
9%
7%
7%
7%
Marketing Services
Fees
Listing
Total Revenue
Cost of Revenue
Accounting Changes
Source: Company reports and JPMorgan estimates.
259
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 170: YHOO Quarterly Income Statement
$ in millions, except per share data
Q1-06
901.5
186.2
FY-2006
Q2-06
Q3-06
933.0
911.5
189.6
209.9
Q4-06
1,015.2
212.7
Q1-07
979.8
203.2
FY-2007E
Q2-07
Q3-07
1,031.9
1,058.7
211.9
223.9
Q4-07E
1,160.7
225.0
Q1-08E
1,146.1
221.2
FY 2008E
Q2-08E
Q3-08E
1,229.3
1,267.9
226.3
227.0
Q4-08E
1,349.7
227.0
1,087.7
1,122.7
1,121.5
1,227.9
1,183.1
1,243.8
1,282.6
1,385.7
1,367.3
1,455.6
1,494.9
1,576.7
Cost of Revenue
178.6
191.0
220.6
214.7
222.9
226.5
252.7
273.0
269.4
283.8
299.0
313.8
Gross Profit
Gross Margin
909.1
83.6%
931.7
83.0%
900.9
80.3%
1013.2
82.5%
960.2
81.2%
1017.3
81.8%
1029.9
80.3%
1112.7
80.3%
1097.9
80.3%
1171.7
80.5%
1196.0
80.0%
1263.0
80.1%
Sales and Marketing
Product Development
G&A
Amortization & stock comp
FAS123 Adjustment
Other Adjustment
Total Expenses
Total Expenses (ex-FAS123R)
292.3
179.9
97.9
30.9
107.0
287.4
172.6
108.4
34.0
99.7
288.6
163.8
91.9
32.8
121.5
299.0
172.1
112.1
27.2
95.1
317.2
191.2
115.7
27.1
140.0
338.3
216.6
123.4
25.2
128.8
340.6
223.1
140.5
30.0
145.5
346.4
242.5
152.4
35.0
175.0
348.7
252.9
161.3
30.0
185.0
362.4
254.7
171.8
30.0
190.0
372.2
254.1
174.9
31.0
195.0
378.4
252.3
173.4
32.0
195.0
707.9
600.9
702.1
602.4
698.6
577.1
705.4
610.3
791.2
651.2
832.3
703.5
879.7
734.1
951.4
776.4
977.9
792.9
1008.9
818.9
1027.3
832.3
1031.1
836.1
Operating Profit
Operating Margin (Reported)
201.2
18.5%
229.6
20.5%
202.3
18.0%
307.8
25.1%
169.0
14.3%
185.0
14.9%
150.2
11.7%
161.4
11.6%
120.0
8.8%
162.8
11.2%
168.7
11.3%
231.8
14.7%
EBITDA
EBITDA Margin
Interest Income
Investment gains (losses)
Contract termination fees
Other
Other income, net
434.9
40.0%
456.9
40.7%
473.7
42.2%
540.4
44.0%
460.0
38.9%
473.6
38.1%
466.3
36.4%
506.4
36.5%
490.0
35.8%
547.8
37.6%
568.7
38.0%
641.8
40.7%
35.4
36.1
50.3
35.2
35.5
30.7
43.7
35.0
40.0
40.0
40.0
40.0
IBT & Minority Interest
Margins
236.6
22%
265.7
24%
252.6
23%
343.1
28%
204.5
17%
215.7
17%
193.9
15%
196.4
14%
160.0
12%
202.8
14%
208.7
14%
271.8
17%
Income Taxes
Tax Rate
102.9
44%
122.7
46%
124.4
49%
108.0
31%
92.4
45%
87.7
41%
78.7
41%
84.4
43%
67.2
42%
85.2
42%
87.6
42%
114.2
42%
IAT
Earnings in Equity Interest
Minority Interest
IAT & Minority Interest
133.7
26.4
(0.3)
159.8
143.0
21.6
(0.3)
164.3
128.2
30.2
0.1
158.5
235.1
33.9
(0.2)
268.7
112.1
29.1
1.2
142.4
128.0
32.1
0.5
160.6
115.3
36.5
(0.5)
151.3
111.9
35.0
146.9
92.8
40.0
132.8
117.6
42.0
159.6
121.0
45.0
166.0
157.7
48.0
205.7
-
-
-
-
-
-
-
-
-
-
-
-
Marketing Services
Fees
Listing
Total Revenue
Accounting Changes
260
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Reported Net Income
Reported EPS GAAP (inc. FAS 123R)
Diluted Shares
Q1-06
159.8
0.11
1,493
FY-2006
Q2-06
Q3-06
164.3
158.5
0.11
0.11
1,477
1,442
Q4-06
268.7
0.19
1,419
Q1-07
142.4
0.10
1,418
FY-2007E
Q2-07
Q3-07
160.6
151.3
0.11
0.11
1,404
1,395
Q4-07E
146.9
0.11
1,395
Q1-08E
132.8
0.10
1,385
FY 2008E
Q2-08E
Q3-08E
159.6
166.0
0.12
0.12
1,375
1,365
Q4-08E
205.7
0.15
1,355
% of Total Revenue
Marketing Services
Fees
Sales and Marketing
Product Development
G&A
83%
17%
26.9%
16.5%
9.0%
83%
17%
25.6%
15.4%
9.7%
81%
19%
25.7%
14.6%
8.2%
83%
17%
24.3%
14.0%
9.1%
83%
17%
26.8%
16.2%
9.8%
83%
17%
27.2%
17.4%
9.9%
83%
17%
26.6%
17.4%
11.0%
84%
16%
25.0%
17.5%
11.0%
84%
16%
25.5%
18.5%
11.8%
84%
16%
24.9%
17.5%
11.8%
85%
15%
24.9%
17.0%
11.7%
86%
14%
24.0%
16.0%
11.0%
Q/Q change
Marketing Services
Fees
Sales and Marketing
Product Development
G&A
2%
0%
3%
12%
3%
3%
2%
-2%
-4%
-2%
-2%
11%
0%
-5%
0%
11%
1%
4%
5%
4%
-3%
-4%
6%
11%
6%
5%
4%
7%
13%
7%
3%
6%
1%
3%
1%
10%
0%
2%
9%
2%
-1%
-2%
1%
4%
1%
7%
2%
4%
1%
4%
3%
0%
3%
0%
3%
6%
0%
2%
-1%
2%
Y/Y Change
Marketing Services
Fees
Revenue
Sales and Marketing
Product Development
G&A
34%
25%
33%
27%
51%
33%
30%
19%
28%
17%
37%
33%
20%
23%
20%
9%
16%
18%
15%
15%
15%
6%
7%
29%
9%
9%
9%
9%
6%
18%
11%
12%
11%
18%
26%
14%
16%
7%
14%
18%
36%
53%
14%
6%
13%
16%
41%
36%
17%
9%
16%
10%
32%
39%
19%
7%
17%
7%
18%
39%
20%
1%
17%
9%
14%
25%
16%
1%
14%
9%
4%
14%
Source: Company reports and JPMorgan estimates.
261
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 171: YHOO Annual Balance Sheet
$ in millions
FY-06
FY-07E
FY-08E
FY-09E
Assets
Cash and cash equivalents
Restricted cash
ST investments in marketable securities
Restricted short-term investments
Accounts receivable, net
Prepaid expenses and other current assets
Total current assets
1,569.9
1,031.5
931.0
217.8
3,750.1
1,813.3
684.2
1,025.4
401.9
3,924.8
3,456.3
684.2
1,182.5
457.2
5,780.2
5,191.9
684.2
1,287.3
497.8
7,661.1
LT investments in marketable securities
Restricted long-term investments
Property and equipment, net
Goodwill
Intangible assets, net
Other assets, net
Investments in equity interests
Total assets
935.9
1,101.4
2,992.1
405.8
460.0
1,891.8
11,537.2
550.6
1,270.3
3,532.3
517.4
529.5
1,989.3
12,314.2
550.6
1,270.3
3,532.3
517.4
529.5
1,989.3
14,169.6
550.6
1,160.3
3,532.3
517.4
529.5
1,989.3
15,940.5
Liabilities and stockholders' equity
Accounts payable
Accrued expenses and other current liabilities
Deferred revenue
Short term debt
Total current liabilities
109.1
1,048.2
318.0
1,475.3
166.3
1,039.3
374.1
749.6
2,329.3
189.2
1,182.5
425.7
749.6
2,547.1
Long Term Deferred
Other liabilities
Minority interests in consolidated subsidiaries
Convertible debt
Total liabilities
64.9
50.5
8.1
749.9
2,348.8
59.0
309.3
8.3
2,705.9
59.0
309.3
8.3
2,923.7
206.0
1,287.3
463.4
749.6
2,706.3
59.0
309.3
8.3
3,082.9
Total stockholders' equity
Total Liabilities and Shareholders' Equity
9,188.4
11,537.2
9,608.3
12,314.2
11,246.0
14,169.6
12,857.7
15,940.5
Source: Company reports and JPMorgan estimates.
262
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 172: YHOO Cash Flow Statement
$ in millions
Net Income
D&A
Tax Benefit
Excess Tax Benefit from SBC
Equity
Minority Interests
Stock Based Compensation
Other Non-Cash Items
Changes in Working Capital
Accounts Receivable
Prepaid Expenses
Accounts Payable
Accrued Charges
Deferred Revenue
Other Operating
Cash From Operations
FY-06
751.3
540.0
529.7
FY-07E
601.2
651.5
103.3
FY-08E
664.1
800.0
360.0
(112.1)
6.3
424.9
(7.8)
(163.7)
1,431.4
(134.3)
14.0
589.3
(56.5)
148.4
1,668.9
(146.2)
765.0
2,442.9
FY-09E
791.8
910.0
200.0
(146.2)
780.0
2,535.7
FCF
1,279.5
1,307.0
1,642.9
1,735.7
INVESTING CASH FLOWS
Capital Expenditures
Net Investment
ST Investment Purch.
ST Investments Mat.
Acquisitions
Cash From Investing
(689.1)
536.8
(334.8)
436.0
(142.6)
(193.7)
(609.8)
246.0
(112.0)
510.7
(355.5)
(320.7)
(800.0)
(800.0)
(800.0)
(800.0)
FINANCING CASH FLOWS
Common Stock Issued
Shares Repurchased
Structured stock repurchase
Excess Tax Benefit from SBC
Other financing activities, net
Long Term Debt
Cash From Financing
318.1
(1,782.1)
(227.7)
537.3
(1,154.5)
243.9
(1,363.2)
(250.0)
247.9
(15.9)
(1,137.3)
-
-
56.9
140.1
32.5
243.5
1,642.9
1,735.7
1,429.8
1,569.9
1,569.9
1,813.4
1,813.3
3,456.3
3,456.3
5,191.9
Foreign Exch Effects
Net Change In Cash
Cash at Beginning
Cash at End
Source: Company reports and JPMorgan estimates.
263
Imran Khan
(1-212) 622-6693
[email protected]
264
North America Equity Research
02 January 2008
China Company Previews
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Baidu, Overweight ($399.67)
We maintain our Overweight rating on Baidu, the dominant market leader in China's
online search market, which is still in an early high-growth stage. We expect the paid
search market in China to experience ~55% CAGR over 2007-2012, driven by: (1)
rising Internet penetration in China, (2) significant growth in websites and pages, (3)
higher search usage, and (4) increased SME search marketing due to relatively higher
ROI. Baidu’s search market share is around 60%-70% (as per different market
research firms) and it also now has the top Internet traffic in China (as per Alexa).
•
Baidu’s fundamentals continue to remain strong. In 3Q07, active online
marketing customers were ~143K, up 12% Q/Q and up 40% Y/Y. Revenue per
online marketing customer was Rmb3,469 (~US$467), up 11% Q/Q and up
49%Y/Y. Going forward, we expect customer numbers to grow at a faster rate
than revenue per customer. Also, by end-3Q07, customer deposits were at Rmb
229M, up 27% Q/Q; we believe the good customer deposit growth sets a good
stage for future revenue growth.
•
We expect Baidu to maintain its leading search engine position in China due to:
(1) its products are tailored better to local needs (eg. music search and Baidu
Knows - community Q&A site), (2) its strong local brand name, (3) good
relationship with the Chinese government, and (4) its good Chinese search
technology.
•
Baidu also has one of the widest distribution networks in China (a key to driving
sales), and remains well ahead of competitors in this regard. As per
management, the company has 60 first-level/large distributors; we believe there
are also more than a thousand second-tier distributors / agents across China. A
wide distribution network remains crucial as the paid search market in China is
still in an early phase of development, and many SME advertisers still need
advice and services from ad agencies.
•
In our view, positive share price drivers include: (1) potential upside from new
revenue sources, such as display ads and Baidu TV, as a majority of its current
traffic is now on non-search properties; (2) continued strong fundamentals in
paid search (still in early high-growth stage), including margin expansion; (3)
potential from long-term strategic investments, such as the Japanese site and
C2C e-commerce platform; and (4) QDII funds showing strong interest in
leading US-listed Chinese names.
•
For 4Q07, we estimate total revenue of US$76.2M, up 15% Q/Q and 119% Y/Y,
and GAAP-diluted EPS of US$0.60, down 14% Q/Q and up 33% Y/Y, with the
Shenzhen distributor transition and Internet Data Center shut-down issues
leading to slightly slower growth in the quarter (we believe these are short-lived
issues, while the longer-term fundamental outlook remains strong).
267
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 173: Baidu Financial Snapshot
US$ millions, except per share data
4Q07E 3Q07A 4Q06A
JPMorgan
Revenue
EBITDA
EPS (GAAP)
EPS (Adj.) *
Consensus
Revenue
EBITDA
EPS (GAAP)
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
76.2
29.0
0.60
0.66
66.3
29.2
0.70
0.72
34.8
16.9
0.45
0.48
119%
72%
33%
37%
15%
-1%
-14%
-9%
230.1
96.1
2.15
2.31
451.0
196.9
4.42
4.65
716.5
315.7
6.99
7.21
118%
100%
99%
83%
96%
105%
106%
101%
59%
60%
58%
55%
76.0
0.72
66.3
29.2
0.70
34.8
16.9
0.45
119% 15%
226.7
418.1
666.0
115%
84%
59%
59% 3%
2.30
4.07
6.33
112%
77%
56%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.
Our Estimates and Outlook for 2008
We forecast 2008 total revenue at US$451M, up 96% Y/Y, and GAAP-diluted EPS
of US$4.42, up 106% Y/Y. We expect active online marketing customers to grow at
~42% Y/Y in 2008 to reach ~220K in 4Q08, and revenue per customer to reach Rmb
4,811 in 4Q08, up 31% Y/Y. In respect of margins, we forecast gross margin at
63.9% for 2008, or relatively stable vs. 63.7% for 2007; adjusted operating margin
(ex-share-based expense) of 35.2% for 2008, up from 32.1% for 2007 (due to better
leverage in SG&A expenses), and adjusted net margin (ex-share-based expense) of
36.7% for 2008, up from 35% for 2007.
Also, Baidu’s Japan search service is set to launch in 4Q07 (with full-year 2007
expense of ~US$15M); however, revenue will likely not come in until late 2008 or
2009. In respect of C2C e-commerce, the business model will be similar to C2C
market leader Taobao (keyword ranking with free store front offered) and is
scheduled to launch in 2008. The company expects spending on the C2C service will
be significantly less than the Japan investment. We are not modeling any revenue
contribution as yet. Also, we do not expect any significant negative revenue impact
from Baidu’s C2C competitors (Taobao and eBay Eachnet), which are still Baidu’s
customers.
Our Estimates and Outlook for 2009
For 2009, we forecast total revenue at US$716.5M, up 59% Y/Y, and GAAP-diluted
EPS of US$6.99, up 58% Y/Y. We forecast active online marketing customers to
reach ~282K in 4Q09, up 28% Y/Y, and revenue per customer to reach Rmb 5,556 in
4Q09, up 15% Y/Y. We forecast gross margin at 62.7% for 2009 (slightly lower
Y/Y); adjusted operating margin (ex-share-based expense) of 35.3% (stable from
prior year) and adjusted net margin (ex-share-based expense) of 36.4% (stable).
268
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Rating and Price Target
We maintain our OW rating on Baidu. Our Dec-08 price target is US$400, based on
a PEG ratio of 1.9x (based on 2009E PE, divided by 2011 estimated earnings
growth), or 1.1x (based on 2009E PE, divided by 2010E earnings growth), largely in
line with valuation on China’s Internet names. The PT implies 90.5x 2008E, 57.2x
2009E, and 38.1x 2010E diluted GAAP P/E (or 86.1x 2008E, 55.5x 2009E, and
37.3x 2010E diluted adjusted P/E).
We believe Baidu’s current valuation can be sustained at least until end-2008 due to:
(1) Internet growth outlook will likely remain unchanged, and Internet penetration in
China is still below 20% vs. the US level of 65%+; also, the number of SMEs using
search is still low, roughly 240k out of around 4 million relatively larger SMEs in
China. (2) Potential pickup in eCommerce after 2008. (3) New revenue sources, such
as Baidu TV and display ads, to provide upside surprise. (4) Investments from
domestic Chinese investors.
In addition, we believe that earnings upside could come from the expansion in Japan,
Baidu TV, banner advertising, C2C e-commerce services and potential margin
expansion.
As with other growth stocks, we believe Baidu’s shares may continue to be volatile.
However, from a 12-month perspective, we expect Baidu to further consolidate its
leading position and increase its monetization rate from growing traffic.
Risks to Our Rating and Price Target
Downside risks to our rating and price target include: (1) Slower-than-expected
online search spending. (2) Large infrastructure-related (servers and bandwidth)
spending. (3) Near-term distributor transition (Baidu is transitioning its sales channel
from distributor sales to direct sales in Shenzhen). (4) Unsuccessful Japan and ecommerce initiatives. (5) Potential margin decline (from bandwidth cost increases,
tax rate increases and significant labor cost increases).
269
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 174: Baidu Income statement
US$ in millions, except per share data, year-end December
Total Revenue
Online marketing services
Other services
COGS
Gross Profit
Operating Expense
SG&A expenses
R&D expenses
Share-based comps expenses
EBIT
Adj. EBIT (ex-share-based exp.)
EBITDA
Net Interest Income
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Net Profit
Adj. Net Profit (ex-share-based exp)
Diluted EPS (US$)
Adj. Diluted EPS (US$, ex-sharebased exp.)
Margins (%)
Gross Margin
Adj. OPM (ex-share-based exp.)
EBITDA Margin
Net Margin
Adj. Net Margin (ex-share-based)
Sequential Growth (%)
Revenue
Gross Profit
EBIT
Net Profit
Adj. Net Profit
Diluted EPS
Adj. Diluted EPS
Source: Company, JPMorgan estimates.
270
1Q06
16.9
16.5
0.4
-5.3
11.6
-8.3
-5.1
-1.5
-1.6
3.4
5.0
6.6
1.1
0.1
4.6
0.7
4.4
6.0
0.13
0.17
2Q06
24.0
23.6
0.3
-7.0
16.9
-9.7
-6.4
-1.8
-1.5
7.3
8.7
10.7
1.3
0.1
8.6
1.3
7.3
8.8
0.21
0.25
3Q06
30.3
30.1
0.2
-8.6
21.7
-12.1
-7.6
-2.4
-2.1
9.6
11.7
14.1
1.4
0.0
11.0
0.3
10.8
12.9
0.31
0.37
4Q06
34.8
34.6
0.2
-9.9
24.8
-11.8
-8.3
-2.6
-0.9
13.0
14.0
16.9
1.5
0.4
15.0
-0.8
15.7
16.7
0.45
0.48
1Q07
35.7
35.6
0.1
-13.2
22.5
-13.0
-8.6
-2.8
-1.6
9.6
11.1
14.9
1.5
0.2
11.3
-0.2
11.1
12.7
0.32
0.36
2Q07
52.7
52.6
0.1
-19.2
33.5
-16.5
-11.9
-3.5
-1.2
16.9
18.1
23.3
1.5
0.4
18.9
-0.2
18.6
19.8
0.54
0.57
3Q07
66.3
66.2
0.1
-24.1
42.2
-19.8
-14.7
-4.3
-0.7
22.4
23.2
29.2
1.6
0.5
24.6
-0.3
24.3
25.0
0.70
0.72
4Q07E
76.2
76.2
0.1
-27.2
49.0
-29.2
-21.9
-5.3
-2.0
19.8
21.8
29.0
1.9
0.0
21.7
-0.5
21.2
23.2
0.60
0.66
1Q08E
76.2
76.1
0.1
-29.1
47.1
-26.1
-18.8
-5.3
-2.0
21.0
23.0
30.4
2.3
0.0
23.3
-0.8
22.5
24.5
0.64
0.69
2Q08E
104.2
104.1
0.1
-37.9
66.3
-32.1
-22.8
-7.3
-2.0
34.2
36.2
45.0
2.5
0.0
36.8
-1.2
35.6
37.6
1.00
1.06
3Q08E
129.4
129.3
0.1
-45.5
83.9
-38.1
-27.1
-9.1
-2.0
45.8
47.8
58.0
3.1
0.0
48.9
-1.5
47.4
49.4
1.33
1.38
4Q08E
141.3
141.2
0.1
-50.3
90.9
-41.0
-29.1
-9.9
-2.0
50.0
52.0
63.5
3.7
0.0
53.7
-1.7
52.0
54.0
1.45
1.51
FY06
105.7
104.5
1.2
-30.8
74.9
-41.7
-27.4
-8.2
-6.1
33.2
39.2
48.1
5.4
0.5
39.0
-1.5
38.1
43.6
1.08
1.26
FY07E
230.1
229.8
0.3
-83.4
146.7
-78.2
-56.8
-15.9
-5.5
68.5
74.0
96.1
6.6
1.1
76.2
-1.2
75.0
80.4
2.15
2.31
FY08E
451.0
450.8
0.2
-162.8
288.2
-137.3
-97.7
-31.6
-8.0
150.9
158.9
196.9
11.7
0.0
162.7
-5.1
157.6
165.6
4.42
4.65
FY09E
716.5
716.3
0.2
-267.4
449.0
-203.8
-142.1
-53.7
-8.0
245.2
253.2
315.7
21.0
0.0
266.2
-13.7
252.5
260.5
6.99
7.21
68.7
29.3
39.0
26.0
35.4
70.6
36.4
44.6
30.5
36.6
71.7
38.7
46.7
35.6
42.5
71.4
40.2
48.5
45.3
48.0
63.1
31.2
41.6
31.0
35.5
63.5
34.4
44.2
35.4
37.6
63.7
35.0
44.1
36.6
37.7
64.3
28.6
38.0
27.9
30.5
61.8
30.1
39.9
29.6
32.2
63.6
34.8
43.2
34.2
36.1
64.9
36.9
44.8
36.6
38.2
64.4
36.8
44.9
36.8
38.3
70.9
37.1
45.6
36.0
41.2
63.7
32.1
41.7
32.6
35.0
63.9
35.2
43.7
34.9
36.7
62.7
35.3
44.1
35.2
36.4
18.8
20.1
90.6
44.5
38.2
45.0
38.7
41.7
45.8
116.0
66.4
46.5
65.8
46.0
26.3
28.2
33.0
47.5
46.4
47.3
46.3
14.8
14.5
35.2
45.9
29.7
45.5
29.4
2.6
-9.3
-26.7
-29.6
-24.1
-29.6
-24.0
47.7
48.7
77.2
68.4
56.6
68.2
56.4
25.7
26.1
32.4
30.1
26.1
29.9
25.9
15.0
16.1
-11.8
-12.5
-7.0
-13.9
-8.5
0.0
-3.9
5.9
6.2
5.7
5.8
5.3
36.8
40.8
63.2
57.8
53.1
57.3
52.6
24.2
26.6
33.9
33.1
31.3
32.7
30.9
9.2
8.4
9.1
9.9
9.5
9.5
9.1
170.7
183.8
656.5
553.8
338.9
543.5
338.7
117.8
95.9
106.6
97.0
84.7
98.5
83.2
96.0
96.5
120.4
110.2
105.8
105.7
101.4
58.9
55.8
62.5
60.3
57.4
58.1
55.3
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 175: Baidu Annual Balance Sheet
US$ in millions, year-end December
Cash & Cash Equivalents
Account Receivables
Other Current Assets
Total Current Assets
Net Fixed Assets
LT Investments
Other LT Assets
Total Long Term Assets
Total Assets
ST Debt
Accrued Expenses and Payables
Other Current Liabilities
Total Current Liabilities
LT Debt
Other LT Liabilities
Total Liabilities
Share Capital
Additional Paid-in Capital
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
Total Liabilities and Equity
FY06
154
3
4
161
36
13
49
210
FY07E
232
8
14
254
75
1
19
96
349
FY08E
436
15
26
477
114
1
18
134
611
FY09E
652
23
38
713
241
1
17
259
972
19
19
38
1
39
0
137
(4)
38
171
210
44
43
87
0
88
0
155
(9)
115
262
349
86
81
166
0
167
0
179
(9)
274
444
611
130
120
250
0
250
0
204
(9)
526
721
972
FY06
38
FY07E
75
FY08E
158
FY09E
253
9
(1)
6
22
5
38
8
62
8
(0)
(3)
13
9
71
(5)
(9)
24
24
135
(7)
(12)
41
37
263
(7)
(12)
44
39
386
(22)
(11)
0
(33)
(59)
(7)
(1)
(66)
(75)
(75)
(187)
(187)
1
0
1
2
44
154
(1)
2
(0)
2
78
232
14
(0)
14
204
436
17
17
216
652
Source: Company reports, JPMorgan estimates.
Table 176: Baidu Annual Cash Flow Statement
US$ in millions, year-end December
Net Income
Add Non cash Expenses/(income)
Depreciation and Amortization
Extra-ordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
Cash Flow from Investing
Purchase of Property, Plant & Equipment
Purchase / Sale of Other LT Assets
Purchase / Sale of Investments
Net Cash from Investing Activities
Cash Flow from Financing
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Change in Cash & Cash Equivalents
Cash & Cash Equivalents at end of period
Source: Company reports, JPMorgan estimates.
271
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
China Finance Online, Overweight
($23.75)
We maintain our Overweight rating on China Finance Online (JRJC). We remain
positive on the current management team's execution capability, and expect
continued business momentum through a significant scaling up of the company’s
core subscriptions business in 2008 and beyond.
272
•
JRJC’s execution capability has significantly improved over the last year,
particularly in its core individual subscription business, where the company has
delivered four back-to-back quarters of record cash inflows. In 3Q07, individual
subscriber cash inflows were a record-high US$11.06M, up 35% Q/Q and 465%
Y/Y; deferred revenue reached US$18.8M, up 31% Q/Q and 563% Y/Y.
Signaling greater business confidence, JRJC also raised its 2008 guidance at the
3Q07 results announcement. JRJC now expects 2008 revenue of US$50-$60M
(up 113% Y/Y at the mid-point) and adj. net income of US$22-$28M (up 150%
Y/Y at the mid-point), driven by continuing strength in its core subscription
business.
•
Although a prolonged downturn (lasting for several quarters) in China’s
domestic stock market may have an adverse effect on demand for JRJC’s
offerings, we believe the company is now significantly better positioned than in
the past to continue on a strong growth path. JRJC has expanded its tele-sales
force from ~90 at the end of 2006 to around 260 as of 3Q07, and is preparing for
a 500-seat call center by mid-2008; we expect this to be a key component of the
company’s subscriber acquisition / up-selling strategy, which should help to
drive significant scaling up of revenues and earnings. Also, the company’s
fundamental analysis product series ‘Value Engine’ remains a differentiated
offering for consumers.
•
We believe the key share price drivers include: (1) continued strong performance
in its core subscriptions business, (2) further strategic acquisitions to expand its
core business, and (3) potentially acquiring an A-share brokerage license, after
having acquired a small HK broker. The key downside risk remains: a prolonged
slow-down in domestic stock market activities.
•
For 4Q07, we estimate net revenues at US$8.8M, up 20% Q/Q and 249% Y/Y,
and GAAP EPS of US$0.11, up 36% Q/Q (and vs. loss of US$0.08 in 4Q06).
Our top-line estimate is 2% above the mid-point of company guidance (US$8.2$9.0M). With the projected strong top-line growth, we expect adjusted operating
margin (ex-share-based expense) to expand to 38.5% in 4Q07, up from 34.5% in
3Q07.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 177: JRJC Financial Snapshot
US$ millions, except per share data
4Q07E
JPMorgan
Revenue
8.8
EBITDA
3.7
EPS (GAAP) 0.11
EPS (Adj.) * 0.16
Consensus
Revenue
8.6
EBITDA
EPS (GAAP) 0.11
3Q07A 4Q06A
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
7.3
2.8
0.08
0.13
2.5
-0.3
-0.08
-0.01
249%
n.m.
n.m.
n.m.
20%
33%
36%
22%
25.8
9.3
0.32
0.46
56.5
28.4
0.92
1.11
106.9
55.2
1.82
2.01
262%
1006%
n.m.
1529%
119%
206%
189%
139%
89%
94%
98%
81%
7.3
2.8
0.08
2.5
-0.3
-0.08
241% 18%
n.m. 30%
25.7
0.32
56.5
0.92
106.0
1.82
261%
n.m.
120%
188%
88%
98%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.
Our Estimates and Outlook for 2008
We forecast 2008 net revenue at US$56.5M, up 119% Y/Y, and GAAP-diluted EPS
of US$0.92, up 189% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.11,
up 139% Y/Y. We expect JRJC’s core subscription business to remain the key driver
on the back of continued solid execution, particularly with the planned tripling of its
tele-sales team by mid-08 (to reach ~760). In respect of margins, we forecast gross
margin at 83.4% for 2008, up slightly from 82.6% for 2007; adjusted operating
margin (ex-share-based expense) of 46.9% for 2008, expanding from 32.2% for 2007
(due to better leverage in operating expenses), and adjusted net margin (ex-sharebased expense) of 44.8% for 2008, up from 38.8% for 2007.
Our Estimates and Outlook for 2009
For 2009, we forecast net revenue at US$106.9M, up 89% Y/Y, and GAAP-diluted
EPS of US$1.82, up 98% Y/Y, or adjusted EPS (ex-share-based expense) of
US$2.01, up 81% Y/Y. We forecast gross margin at 84.0% for 2009 (up slightly
Y/Y); adjusted operating margin (ex-share-based expense) of 48.2% (slight
expansion) and adjusted net margin (ex-share-based expense) of 43.2% (down
slightly due to slightly higher tax rate assumption).
Rating and Price Target
We maintain our Overweight rating on JRJC. Our Dec-08 price target is US$36,
which implies ’08 / ’09 PE of 32x / 18x on our adjusted diluted EPS estimates (or
GAAP PE of 39x /20x), on the back of ’08E / ’09E / ‘10E adjusted diluted EPS
growth of 139% / 81% / 22%. The price target is slightly above our DCF valuation of
~US$33 (based on WACC of 14% & terminal growth of 0%) due to the strong
growth prospects.
Risks to Our Rating and Price Target
Downside risks to our rating and price target are: (1) prolonged slowdown in
domestic stock market activities (which have historically impacted demand for
JRJC’s products), (2) increased competition in financial analysis software, (3)
management bandwidth in managing the expanding business scale (core business)
and wider portfolio (institutional subscriptions, HK brokerage, advertising).
273
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 178: China Finance Online Income statement
US$ in millions, except per share data, year-end December
Revenue
Subscriptions
Online Ads
Wireless / Stockstar / Others
COGS
Gross Profit
Operating Expenses
Sales & Mktg. expenses
G&A expenses
R&D expenses
Other expenses
Share-based comp. expense (123R)
EBITDA
EBIT
Adj. EBIT (ex-123R expense)
Net Interest Income
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Net Profit (GAAP Reported)
Adj. Net Profit (ex-123R exp.)
Pre Tax EPS (US$)
EPS (US$)
Diluted EPS (Reported, US$)
Adj. Diluted EPS (ex-123R exp.,
US$)
Margins (%)
Gross Margin
Operating Margin (ex-123R exp.)
EBITDA Margin
Net Margin
Adj. Net Margin (ex-123R exp.)
Sequential Growth (%)
Revenue
Gross Profit
Adj. EBIT (ex-123R exp.)
Pre Tax Profit
Adj. Net Profit (ex-123R exp.)
Adj. Diluted EPS (ex-123R exp.)
1Q06
1.41
0.87
0.54
0.00
-0.17
1.23
-1.48
-0.68
-0.76
-0.05
0.00
0.44
0.23
-0.25
0.19
0.26
0.09
0.11
0.01
0.10
0.54
0.01
0.01
0.00
0.03
2Q06
1.47
0.96
0.51
0.00
-0.28
1.19
-1.15
-0.35
-0.66
-0.14
0.00
0.23
0.31
0.04
0.26
0.26
0.15
0.45
0.01
0.44
0.67
0.02
0.02
0.02
0.03
3Q06
1.73
1.38
0.35
0.00
-0.30
1.44
-1.19
-0.30
-0.77
-0.12
0.00
0.30
0.62
0.25
0.54
0.27
0.06
0.58
0.02
0.56
0.85
0.03
0.03
0.03
0.04
4Q06
2.52
2.03
0.19
0.30
-0.60
1.92
-2.66
-1.23
-0.90
-0.31
0.00
-0.23
-0.30
-0.74
-0.52
0.21
-1.24
-1.77
-0.08
-1.70
-0.15
-0.09
-0.09
-0.08
-0.01
1Q07
4.00
3.39
0.25
0.36
-0.82
3.18
-2.81
-1.22
-0.87
-0.32
0.00
-0.39
0.94
0.37
0.77
0.25
0.06
0.69
-0.09
0.78
1.17
0.04
0.04
0.04
0.06
2Q07
5.72
4.93
0.40
0.40
-1.08
4.64
-3.59
-1.33
-1.25
-0.42
0.00
-0.60
1.87
1.05
1.65
0.25
0.11
1.41
-0.15
1.56
2.16
0.07
0.08
0.08
0.11
3Q07
7.30
6.38
0.50
0.42
-1.19
6.11
-4.67
-1.85
-1.16
-0.58
0.00
-1.08
2.78
1.44
2.52
0.24
0.04
1.73
-0.18
1.90
2.98
0.09
0.10
0.08
0.13
4Q07E
8.79
7.92
0.45
0.42
-1.41
7.39
-5.08
-2.02
-1.32
-0.66
0.00
-1.08
3.69
2.31
3.39
0.32
0.00
2.63
0.00
2.63
3.71
0.14
0.14
0.11
0.16
1Q08E
10.18
8.88
0.47
0.83
-1.77
8.40
-5.56
-2.34
-1.42
-0.71
0.00
-1.08
4.27
2.84
3.93
0.37
0.00
3.21
0.43
2.77
3.85
0.17
0.15
0.12
0.17
2Q08E
12.10
10.74
0.48
0.88
-2.06
10.04
-6.04
-2.54
-1.57
-0.85
0.00
-1.08
5.51
4.00
5.08
0.39
0.00
4.39
0.55
3.83
4.91
0.23
0.20
0.17
0.22
3Q08E
14.96
13.55
0.50
0.92
-2.47
12.49
-6.47
-2.84
-1.65
-0.90
0.00
-1.08
7.62
6.02
7.10
0.44
0.00
6.46
0.75
5.69
6.77
0.34
0.30
0.25
0.30
4Q08E
19.30
17.83
0.51
0.95
-3.10
16.20
-6.87
-3.09
-1.74
-0.96
0.00
-1.08
11.01
9.33
10.41
0.50
0.00
9.84
1.09
8.73
9.81
0.52
0.46
0.38
0.43
FY06
7.13
5.24
1.59
0.30
-1.36
5.77
-6.48
-2.56
-2.12
-0.61
0.00
-1.19
0.84
-0.70
0.48
1.00
-0.94
-0.64
-0.04
-0.60
0.59
-0.03
-0.03
-0.03
0.03
FY07E
25.81
22.62
1.60
1.59
-4.49
21.32
-16.15
-6.42
-4.60
-1.97
0.00
-3.15
9.28
5.17
8.32
1.07
0.21
6.45
-0.41
6.86
10.02
0.34
0.36
0.32
0.46
FY08E
56.53
51.00
1.95
3.58
-9.40
47.13
-24.94
-10.81
-6.38
-3.42
0.00
-4.32
28.40
22.20
26.52
1.69
0.00
23.89
2.82
21.03
25.35
1.26
1.11
0.92
1.11
FY09E
106.89
100.56
2.20
4.13
-17.14
89.75
-42.55
-19.92
-11.29
-7.02
0.00
-4.32
55.21
47.20
51.52
2.92
0.00
50.12
8.17
41.91
46.23
2.62
2.19
1.82
2.01
87.6
13.5
16.7
6.9
38.1
80.9
18.0
21.3
30.1
45.5
82.8
31.3
35.5
32.1
49.2
76.1
-20.5
-11.8
-67.2
-5.9
79.6
19.2
23.5
19.4
29.2
81.1
28.8
32.6
27.3
37.7
83.7
34.5
38.0
26.0
40.8
84.0
38.5
42.0
29.9
42.2
82.6
38.6
41.9
27.2
37.9
83.0
42.0
45.5
31.7
40.6
83.5
47.5
50.9
38.0
45.3
84.0
54.0
57.1
45.3
50.9
81.0
6.7
11.8
-8.4
8.2
82.6
32.2
36.0
26.6
38.8
83.4
46.9
50.2
37.2
44.8
84.0
48.2
51.7
39.2
43.2
-26.1
-29.8
-73.7
-90.6
-49.7
-50.5
4.3
-3.7
38.9
315.7
24.4
21.7
18.1
20.9
105.7
28.1
27.9
31.2
45.5
33.7
-195.0
-408.3
n.m.
n.m.
58.4
65.7
-248.6
-138.9
n.m.
n.m.
43.2
46.1
115.0
104.6
84.8
85.1
27.6
31.6
52.9
22.2
38.2
25.0
20.4
20.9
34.3
52.1
24.3
22.2
15.8
13.8
15.9
22.3
4.0
4.6
18.8
19.5
29.4
36.6
27.4
27.2
23.7
24.4
39.8
47.2
37.9
37.7
29.0
29.8
46.6
52.3
44.9
44.6
-4.7
-17.6
-85.1
nm
-87.3
-87.1
262.1
269.4
1,630.6
nm
1,612.3
1,529.3
119.0
121.1
218.6
270.2
153.1
138.9
89.1
90.4
94.3
109.8
82.3
81.1
Source: Company, JPMorgan estimates. Note: We have included 123R share-based compensation adjustments starting 2006.
274
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 179: JRJC Annual Balance Sheet
US$ in millions, year-end December
FY06
45.0
0.5
1.1
46.5
2.3
(0.6)
1.7
10.3
12.6
24.6
71.1
FY07E
66.8
1.7
2.9
71.4
5.4
(1.3)
4.2
13.6
12.6
30.4
101.9
FY08E
108.4
3.8
6.0
118.2
12.2
(2.9)
9.4
13.6
12.6
35.6
153.8
FY09E
163.9
5.5
11.3
180.8
25.1
(6.3)
18.8
13.6
12.6
45.0
225.8
ST Debt and Current Portion of LT Debt
Accounts Payable (Accrued expenses, etc.)
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Long Term Liabilities
Total Long Term Liabilities
Share Capital
Share Premium
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
2.1
6.4
8.5
0.1
0.1
0.0
52.6
1.6
8.2
62.5
3.8
17.6
21.4
2.1
2.1
0.0
59.7
3.5
15.1
78.3
8.4
30.9
39.3
1.5
1.5
0.0
73.4
3.5
36.1
113.0
11.2
44.9
56.1
1.0
1.0
0.0
87.1
3.5
78.0
168.6
Total Liabilities and Equity
71.1
101.9
153.8
225.8
FY06
(0.6)
0.4
1.2
FY07E
6.9
1.0
3.2
FY08E
21.0
1.9
0.0
4.3
FY09E
41.9
3.7
0.0
4.3
(0.3)
0.1
1.7
4.5
6.9
(1.3)
(1.8)
1.8
11.2
20.8
(2.1)
(3.1)
4.6
13.3
40.0
(1.7)
(5.3)
2.8
14.0
59.7
(1.4)
(10.3)
2.4
(9.3)
(3.1)
(3.6)
(0.0)
(6.8)
(6.8)
(0.3)
(7.1)
(12.8)
(0.3)
(13.1)
0.1
1.0
0.0
1.2
(1.2)
45.0
2.0
5.8
(0.0)
7.8
21.8
66.8
(0.6)
9.4
(0.0)
8.7
41.6
108.4
(0.4)
9.4
(0.0)
8.9
55.5
163.9
Cash & Cash Equivalents
Accounts Receivable
Inventory
Total Other Current Assets
Total Current Assets
Gross Fixed Assets
Accumulated Depreciation
Net Fixed Assets
Other Long Term Assets
Long Term Investments and Associates
Total Long Term Assets
Total Assets
Source: Company reports, JPMorgan estimates.
Table 180: JRJC Annual Cash Flow Statement
US$ in millions, year-end December
Net Income
Non cash Expenses/(income)
Depreciation and Amortization
Extraordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
Purchase of Property, Plant & Equipment
Purchase/Sale of Other LT assets
Purchase/Sale of Investments
Net Cash from Investing Activities
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Effect of Exchange Rate Changes
Net Change in Cash and Cash Equivalents
Cash & CE at End of Period
Source: Company reports, JPMorgan estimates.
275
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
NetEase, Neutral ($19.33)
We maintain our Neutral rating on NetEase. Although the stock’s valuation is
relatively low, we believe NetEase still lacks revenue drivers in the near to medium
term, or the next big game to drive earnings growth. While WWJ3 has
commercialized, and the results are respectable, we believe investors will wait for the
next games: we expect TianXia 2 and Datang free-model to launch in 2Q08.
However, we believe investors will not get excited easily (or pay high valuation),
given limited success in the first versions of Datang and TianXia2.
276
•
NetEase remains in a period of transition in its online games business, in our
view. While we expect its online game revenue to register ~7% growth in 4Q07
(with WWJ3 to offset the decline in WWJ2), NetEase currently lacks a
successful new game for sustainable growth. TianXia2 launch in 1Q08 is closedbeta, with commercialization at the very earliest in mid-2Q08. Datang’s itembased model launch is also delayed to around mid-08.
•
In respect of Fantasy WWJ (still the flagship game), we expect the game to see
flattish growth in 4Q07, due to seasonally flat Q4. We expect FWJ to peak out in
3Q08; and to observe a single-digit quarterly decline going forward.
•
Despite the near-term transition, we remain positive on NetEase in the long run.
As a leading online game developer in China, with proven game operating
capability, we believe the company is well positioned to capture growth in
China’s online games industry in the long run. In addition, NetEase has the
largest free email user base in China. We believe NetEase can leverage this user
base and its portal traffic to monetize through online advertising and search
services.
•
The share price drivers over the next six months include: (1) news on WWJ3
progress, (2) FWJ anniversary activities in Jan, and (3) TianXia2 closed beta in
1Q08. Upside risks include: upside from future licensed games or existing
games, better-than-expected advertising growth. Downside risks include: future
delay in game launches, unsuccessful new licensed games.
•
For 4Q07, we estimate net revenue of US$78.0M, up 7% Q/Q and up 17% Y/Y,
and GAAP diluted EPS of US$0.30, up 12% Q/Q as well as Y/Y. For online
games, we expect net revenue of US$64.6M, up 7% Q/Q and 15% Y/Y, with
flattish growth for FWJ and WWJ3 offsetting the decline in WWJ2.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 181: NetEase Financial Snapshot
US$ millions, except per share data
4Q07E 3Q07A 4Q06A
JPMorgan
Revenue
EBITDA
EPS (GAAP)
EPS (Adj.) *
Consensus
Revenue
EBITDA
EPS (GAAP)
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
78.0
49.9
0.30
0.33
73.1
41.8
0.27
0.29
66.5
44.4
0.27
0.29
17%
12%
12%
13%
7%
19%
12%
11%
290.4
183.4
1.17
1.26
326.5
203.5
1.24
1.35
374.0
225.2
1.32
1.43
8%
2%
7%
7%
12%
11%
6%
7%
15%
11%
7%
6%
76.0
0.30
73.1
41.8
0.27
66.5
44.4
0.27
14% 4%
12% 12%
289.0
326.9
380.9
8%
13%
17%
1.18
1.25
1.39
8%
6%
11%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.
Our Estimates and Outlook for 2008
For 2008, we forecast net revenue at US$326.5M, up 12% Y/Y, and GAAP-diluted
EPS of US$1.24, up 6% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.35,
up 7% Y/Y. We expect new versions of TianXia 2, Datang (item-based model), and
FlyFF to be launched in 1H08; we have also modeled in one new licensed game to be
commercialized in May 2008. Overall, we forecast online game revenues of
US$263.9M, up 7% Y/Y, with a slight decline in FWJ revenue and continued decline
in WWJ2, to be offset by contribution from WWJ3, and other games.
After a flattish year for online ad revenue, we expect NetEase to achieve industry
growth of ~50% in 2008. In order to drive online ad revenue growth, we expect
NetEase to continue to focus on improving its content in news, entertainment, sports,
female, and finance channels. In addition, the company plans to improve its email
services in order to further expand available ad inventory.
In respect of margins, we expect NetEase to see a slight decline in 2008.
Our Estimates and Outlook for 2009
For 2009, we forecast net revenue at US$374.0M, up 15% Y/Y, and GAAP diluted
EPS of US$1.32, up 7% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.43,
up 6% Y/Y. For online games, we forecast revenue of US$295.3M, up 12% Y/Y; we
expect the company to in-house develop 1 to 2 games during 2009. In respect of
margins, we estimate gross margin at 77.6% for 2009 (down slightly Y/Y); adjusted
operating margin (ex-share-based expense) of 54.6% (down slightly Y/Y) and
adjusted net margin (ex-share-based expense) of 50.9% (also down Y/Y).
Rating and Price Target
We maintain our Neutral rating on NetEase. We believe NetEase still lacks revenue
drivers in the near to medium term, or the next big game to drive earnings growth.
Our Dec-08 price target of US$18 implies 14.5x 2008E and 13.6x 2009E GAAP P/E,
(or 13.4x 2008E and 12.6x 2009E adj. diluted P/E). Our price target is slightly below
our DCF valuation of ~US$22. We note that NetEase traded at around 12x forward
P/E at the last trough, which would suggest a potential share price bottom of around
US$16.
277
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Risks to Our Rating and Price Target
Downside risks to our rating and price target include: intense competition resulting in
negative industry environment, hacking or pirated server issues limiting user growth,
delays in game launches, and significant increase in R&D expenses. Upside risks
include: better-than-expected acceptance of its new games, extended life cycle of
existing games on the back of new upgrade packs, and upside in online advertising.
278
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 182: NetEase Income Statement
US$ in millions, except per share data, year-end December
Revenue
Wireless & other
Advertising
Online Games
COGS
Gross Profit
Operating Expense
Sales & Mktg. expenses
G&A expenses
R&D expenses
Other expenses
Share-based compensation
EBIT
Adj. EBIT (ex-123R expense)
EBITDA
Net Interest Income
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Net Profit
Adj. Net Profit (ex-123R exp.)
Pre Tax EPS (US$)
After Tax EPS (US$)
Diluted EPS (US$)
Adj. Diluted EPS (US$, ex-123R
exp.)
Margins (%)
Gross Margin
Operating Margin (ex-123R exp.)
EBITDA Margin
Net Margin
Adj. Net Margin (ex-123R exp.)
Sequential Growth (%)
Revenue
Gross Profit
Adj. EBIT
Pre Tax Profit
Net Profit (ex-123R exp.)
Diluted EPS
Adj. Diluted EPS (ex-123R exp.)
1Q06
63.5
2.1
7.0
54.3
-10.4
53.0
-14.7
-4.7
-3.8
-3.0
0.0
-3.2
38.3
41.6
43.4
2.8
-0.3
40.9
4.3
36.6
39.9
0.31
0.28
0.26
0.28
2Q06
69.1
2.5
7.9
58.8
-11.4
57.8
-17.3
-4.9
-4.3
-4.9
0.0
-3.3
40.4
43.7
45.8
3.0
0.0
43.4
4.1
39.3
42.6
0.33
0.30
0.28
0.30
3Q06
69.4
2.5
9.7
57.2
-12.2
57.2
-17.2
-5.1
-4.7
-4.0
0.0
-3.3
40.1
43.4
45.9
3.1
0.2
43.4
3.6
39.8
43.1
0.34
0.31
0.29
0.31
4Q06
66.5
2.1
8.5
56.0
-12.0
54.4
-16.3
-4.1
-5.3
-4.0
0.0
-3.0
38.1
41.1
44.4
2.9
0.2
41.2
4.7
36.5
39.4
0.32
0.29
0.27
0.29
1Q07
69.1
2.1
6.7
60.3
-13.0
56.1
-15.6
-5.1
-3.5
-4.4
0.0
-2.6
40.5
43.1
46.2
3.0
-0.1
43.4
4.4
39.0
41.7
0.34
0.31
0.29
0.31
2Q07
70.4
2.2
7.9
60.4
-12.4
58.1
-19.3
-5.9
-5.1
-4.7
0.0
-3.6
38.8
42.3
45.5
3.7
-1.2
41.3
0.3
41.1
44.6
0.33
0.33
0.31
0.34
3Q07
73.1
2.2
10.4
60.5
-13.6
59.5
-24.4
-10.6
-5.3
-5.1
0.0
-3.5
35.1
38.6
41.8
3.9
-1.6
37.4
2.7
34.7
38.2
0.31
0.28
0.27
0.29
4Q07E
78.0
2.2
11.2
64.6
-14.5
63.5
-20.7
-6.7
-5.5
-5.1
0.0
-3.5
42.8
46.3
49.9
3.3
0.0
46.1
6.2
39.9
43.4
0.38
0.33
0.30
0.33
1Q08E
76.5
2.2
10.6
63.7
-14.7
61.8
-21.1
-6.5
-5.4
-5.7
0.0
-3.5
40.7
44.2
47.9
3.4
0.0
44.1
6.0
38.2
41.7
0.37
0.32
0.29
0.32
2Q08E
78.1
2.3
13.3
62.6
-15.2
62.9
-21.1
-6.2
-5.5
-5.9
0.0
-3.5
41.9
45.4
49.2
3.4
0.0
45.3
6.1
39.2
42.7
0.38
0.33
0.30
0.33
3Q08E
86.0
2.3
14.5
69.3
-17.7
68.3
-22.9
-6.9
-6.0
-6.5
0.0
-3.5
45.5
49.0
53.4
3.7
0.0
49.2
6.6
42.6
46.1
0.41
0.36
0.33
0.35
4Q08E
85.8
2.3
15.2
68.3
-18.0
67.8
-22.8
-6.9
-6.0
-6.4
0.0
-3.5
45.0
48.5
53.0
4.1
0.0
49.1
6.6
42.5
46.0
0.41
0.35
0.32
0.35
FY06
268.5
9.2
33.0
226.3
-46.0
222.5
-65.6
-18.8
-18.0
-16.0
0.0
-12.8
156.9
169.7
179.6
11.9
0.1
168.9
-16.7
152.2
165.0
1.31
1.18
1.09
1.18
FY07E
290.4
8.6
36.0
245.7
-53.3
237.1
-80.0
-28.3
-19.3
-19.2
0.0
-13.1
157.1
170.2
183.4
14.0
-2.8
168.2
-13.5
154.8
167.9
1.36
1.25
1.17
1.26
FY08E
326.5
9.1
53.5
263.9
-65.6
260.9
-87.8
-26.5
-22.9
-24.5
0.0
-14.0
173.1
187.1
203.5
14.6
0.0
187.7
-25.2
162.5
176.5
1.56
1.35
1.24
1.35
FY09E
374.0
9.8
68.9
295.3
-83.7
290.3
-100.0
-31.8
-26.2
-28.0
0.0
-14.0
190.3
204.3
225.2
19.7
0.0
210.0
-33.6
176.4
190.4
1.72
1.44
1.32
1.43
83.6
65.5
68.4
57.7
62.8
83.5
63.2
66.3
56.8
61.6
82.5
62.5
66.1
57.4
62.1
81.9
61.8
66.8
54.9
59.3
81.2
62.4
66.9
56.5
60.3
82.5
60.1
64.6
58.3
63.4
81.4
52.8
57.2
47.5
52.3
81.4
59.3
64.0
51.2
55.7
80.8
57.8
62.6
49.9
54.4
80.6
58.1
62.9
50.2
54.7
79.5
57.0
62.1
49.6
53.6
79.0
56.5
61.8
49.6
53.6
82.9
63.2
66.9
56.7
61.4
81.6
58.6
63.1
53.3
57.8
79.9
57.3
62.3
49.8
54.1
77.6
54.6
60.2
47.2
50.9
9.6
10.9
15.2
6.8
16.3
7.9
17.4
8.9
8.9
5.1
6.1
6.8
7.5
7.0
0.4
-0.9
-0.8
0.0
1.3
2.9
2.8
-4.3
-4.9
-5.3
-5.1
-8.5
-6.7
-6.9
3.9
3.0
4.9
5.4
5.6
7.4
6.1
2.0
3.5
-1.8
-4.7
7.1
8.1
10.1
3.8
2.5
-8.8
-9.5
-14.4
-13.9
-12.8
6.7
6.7
19.9
23.3
13.6
12.1
10.8
-1.9
-2.6
-4.4
-4.3
-4.0
-3.2
-2.9
2.1
1.8
2.6
2.7
2.5
3.9
3.7
10.1
8.6
8.0
8.7
8.0
8.1
7.4
-0.2
-0.8
-1.0
-0.2
-0.2
-0.7
-0.7
36.2
36.1
42.1
34.5
44.8
36.3
47.7
8.2
6.6
0.3
-0.4
1.8
6.7
6.8
12.4
10.1
9.9
11.6
5.1
6.5
6.6
14.6
11.3
9.2
11.9
7.9
6.6
6.0
Source: Company, JPMorgan estimates.
279
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 183: NetEase Annual Balance Sheet
US$ in millions, year-end December
Cash and Cash Equivalents
Account Receivables
Inventory
Total Other Current Assets
Total Current Assets
Gross Fixed Assets
Accumulated Depreciation
Net Fixed Assets
Other Long Term Assets
Long Term Investments and Associates
Total Long Term Assets
Total Assets
FY06
496.6
16.6
0.0
7.5
520.7
53.0
(24.7)
28.3
2.6
0.0
30.8
551.6
FY07E
516.5
15.2
0.0
11.6
543.3
67.8
(40.9)
26.9
6.8
0.0
33.7
576.9
FY08E
680.3
16.9
0.0
13.8
711.0
98.6
(57.8)
40.8
6.8
0.0
47.7
758.7
FY09E
897.7
19.5
0.0
15.3
932.6
133.6
(78.7)
54.9
6.8
0.0
61.7
994.3
ST Debt and Current Portion of LT Debt
Accounts Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Long Term Liabilities
Total Long Term Liabilities
Share Capital
Share Premium
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
0.0
32.3
53.0
85.3
98.4
1.4
99.8
0.3
50.7
20.6
294.9
0.0
366.4
87.7
29.4
51.4
168.5
0.0
1.3
1.3
0.3
22.8
(79.3)
463.2
0.0
407.1
88.7
37.0
57.2
183.0
0.0
1.4
1.4
0.4
23.0
(80.2)
631.1
0.0
574.3
88.7
46.2
66.0
201.0
0.0
1.4
1.4
0.4
64.3
(80.2)
807.5
0.0
792.0
Total Liabilities and Equity
551.6
576.9
758.7
994.3
Net Income
Add Non cash Expenses/(income)
Depreciation and Amortization
Extraordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
FY06
152.2
0.0
9.9
(0.1)
12.8
0.0
(7.8)
0.0
(1.2)
12.2
20.7
198.7
FY07E
154.8
0.0
13.1
0.0
13.1
0.0
2.2
0.0
(3.7)
(4.4)
(4.1)
171.0
FY08E
162.5
0.0
16.4
0.0
14.0
0.0
(1.6)
0.0
(2.1)
7.3
5.3
201.8
FY09E
176.4
0.0
20.9
0.0
14.0
0.0
(2.6)
0.0
(1.6)
9.2
8.8
225.2
Purchase of Property, Plant & Equipment
Purchase/Sale of Other LT assets
Purchase/Sale of Investments
Net Cash from Investing Activities
(22.2)
(2.4)
0.0
(24.6)
(10.5)
(4.1)
0.0
(14.5)
(30.0)
0.0
0.0
(30.0)
(35.0)
0.0
0.0
(35.0)
(4.8)
1.4
(101.1)
0.0
1.0
(103.5)
0.0
70.6
496.6
(15.2)
(0.2)
(144.1)
0.0
0.0
(159.5)
0.0
(3.0)
516.5
0.0
0.0
(14.1)
0.0
0.0
(14.1)
0.0
157.8
680.3
0.0
0.0
27.2
0.0
(0.0)
27.2
0.0
217.4
897.7
Source: Company reports, JPMorgan estimates.
Table 184: NetEase Annual Cash Flow Statement
US$ in millions, year-end December
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Effect of Exchange Rate Changes
Net Change in Cash and Cash Equivalents
Cash at End of Period
Source: Company reports, JPMorgan estimates.
280
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Ninetowns, Underweight ($3.45)
We maintain our Underweight rating on Ninetowns (NINE). NINE’s core B2G
(business-to-government) e-filings business continues to face a tough environment
due to the availability of a free substitute. Further, its new B2B segment is likely to
remain in investment / development phase at least till the end of 2007, with limited
visibility on prospects over the coming year.
•
NINE’s core iDeclare.CIQ software sales continue to face a challenging business
environment due to the free alternative distributed by the government. Further,
paid service contract renewals remain muted and the transitioning of free users
to paid ones through such service contracts is yet to be seen.
•
In respect of the NINE’s B2B initiatives, visibility into prospects of the
company’s B2B platform (in a highly competitive space) and size of potential
revenue streams remains low. Also, we believe NINE will need to spend
significantly on marketing its B2B services over the next year (around its official
launch), leading to margin pressures over the next several quarters. With the
core B2G business also facing a tough environment, we expect NINE to witness
further operating losses in the near term (after recording losses in 4Q06 and
1Q07).
•
We do not expect any near-term share price drivers for NINE, given that any
meaningful improvement in overall business performance may require at least a
few more quarters. The key upside risk is if NINE becomes a potential
acquisition or partnership prospect: NINE has a customer list of ~132K
importers & exporters (installed base of iDeclare users), implying an enterprise
value/customer of only ~US$130.
•
For 2Q07 (still to be reported), we forecast net revenue of US$3.1M, up 10%
Q/Q but down 38% Y/Y, and a loss of US$0.04 as GAAP diluted EPS (vs. a loss
of US$0.02 in 1Q07 and a profit of US$0.06 per diluted share in 2Q06).
Table 185: Ninetowns Financial Snapshot
US$ millions, except per share data
2Q07E
JPMorgan
Revenue
3.1
EBITDA
-1.3
EPS (GAAP) -0.04
EPS (Adj.) * -0.03
Consensus
Revenue
na
EBITDA
na
EPS (Adj.) *
na
1Q07A 2Q06A
Y/Y Q/Q
F'06
F'07E F'08E
F'06 Y/Y F'07E Y/Y F'08E Y/Y
2.8
-0.9
-0.02
-0.02
5.0
2.3
0.06
0.07
-38%
n.m.
n.m.
n.m.
10%
n.m.
n.m.
n.m.
19.3
5.9
0.16
0.20
13.0
-3.9
-0.12
-0.09
15.0
0.8
-0.01
0.01
-34%
-65%
-69%
-61%
-33%
n.m.
n.m.
n.m.
15%
n.m.
n.m.
n.m.
2.8
-0.9
-0.02
5.0
2.3
0.07
-
-
19.3
5.9
0.20
na
na
na
na
na
na
-34%
-65%
-61%
-
-
Source: JPMorgan estimates. *Note: Adjusted EPS excludes share-based compensation expense.
281
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
For 2008, we forecast net revenues of US$15.0M, up 15% Y/Y, and a GAAP loss of
US$0.01 per share (vs. GAAP loss of US$0.12 per share for 2007), or adjusted EPS
(ex-share-based expense) of US$0.01 (vs. GAAP loss of US$0.09 per share for
2007). In respect of margins, we forecast gross margin at 87.5% for 2008, down
slightly from 89.0% for 2007; adjusted operating loss margin (ex-share-based
expense) of 10.5% (operating loss) for 2008, narrowing from operating loss margin
of 44.3% for 2007, and adjusted net margin (ex-share-based expense) of 3.0% for
2008, vs. net loss margin of 25.3% for 2007.
Our top-line estimate calls for 7% Y/Y increase in enterprise software revenue (74%
of total revenues in 2008E) and 26% Y/Y increase in software development service
revenue (22% of total revenues). We also forecast the B2B business to begin
contributing to revenues, although very modestly (4% of total revenues). We believe
the potential for upside surprise in company performance would be dependent on
NINE’s success in its B2B initiatives and the company's execution on paid service
contracts (new and renewal contracts) in the B2G segment.
Rating and Price Target
We maintain our Underweight rating on NINE, given: (1) NINE’s core iDeclare.CIQ
software sales remain challenged due to availability of a free alternative (from the
government); (2) Paid service contract renewals remain muted and the transitioning
of free software users to paid ones through such service contracts is yet to be seen;
(3) Visibility on the prospects of NINE's B2B platform remains low; (4) NINE will
incur significant operating expenses on its B2B services (marketing, etc.) leading to
margin pressures over the next several quarters.
Our DCF-based Dec-07 price target is US$3.2, which implies 251x on our 2008E
adjusted EPS. (The implied EV at our target price is ~US$26M)
Overall, we believe a turnaround for the company is still at least a few quarters away,
and the share price performance is likely to remain weak in the interim. (We also
expect the total cash balance to be down to ~US$2.5 per share at end-4Q07,
compared to US$3.3 per share as of 1Q07).
Risks to Our Rating and Price Target
Upside risks to our rating and price target include: 1) Possibility of NINE becoming
a target for acquisition or strategic partnership (with current EV/customer of only
~US$130); 2) Earlier-than-expected progress on business transition to B2B; 3)
Significant conversions from free e-filing software to NINE’s paid software / service
contracts. Downside risks to our estimates include: 1) Accelerated decline in existing
core revenue base; 2) Larger-than-expected investments in the new B2B business; 3)
Disruption in the working relationship between the PRC Inspections Administration
and the company.
282
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 186: Ninetowns Income Statement
US$ in millions, except per share data, year-end December
Revenue
Enterprise software
Software development service
Other
COGS
Gross profit
Operating expense
Sales & mktg. expenses
G&A expenses
R&D expenses
Other expenses
Share-based compensation
EBIT
Adj. EBIT (ex-123R expense)
EBITDA
Net interest income
Net other income
Pre-tax profit
Tax expense/(credit)
Net profit
Adj. Net profit (ex-123R exp.)
Pre-tax EPS (US$)
After-tax EPS (US$)
Diluted EPS (US$)
Adj. Diluted EPS (ex-123R exp.,
US$)
Margins (%)
GPM
OPM (ex-123R exp.)
EBITDA margin
Net margin
Adj. Net margin (ex-123R exp.)
Sequential growth (%)
Revenue
Gross profit
Adj. EBIT
Pre-tax profit
Net profit (ex-123R exp.)
Diluted EPS
Adj. Diluted EPS (ex-123R exp.)
1Q06
6.1
5.0
1.1
0.0
-0.3
5.8
-3.3
-0.9
-1.9
-0.6
0.0
-0.5
2.4
2.9
3.1
0.6
0.0
3.0
0.1
2.9
3.3
0.08
0.08
0.08
2Q06
5.0
4.0
1.0
0.0
-0.4
4.6
-2.9
-0.3
-1.9
-0.6
0.0
-0.3
1.8
2.0
2.3
0.6
0.0
2.3
0.1
2.3
2.6
0.07
0.07
0.06
3Q06
3.7
3.2
0.5
0.0
-0.2
3.5
-2.8
-0.2
-1.7
-0.9
0.1
-0.3
0.8
1.1
1.4
0.6
0.0
1.4
0.0
1.4
1.7
0.04
0.04
0.04
4Q06
4.5
2.5
2.0
0.0
-1.3
3.2
-4.7
-0.3
-2.7
-1.7
0.0
-0.3
-1.5
-1.3
-1.0
0.7
0.0
-0.8
-0.1
-0.8
-0.5
-0.02
-0.02
-0.02
1Q07
2.8
2.4
0.5
0.0
-0.3
2.5
-4.0
-1.0
-2.1
-1.0
0.0
-0.2
-1.5
-1.3
-0.9
0.6
0.1
-0.8
0.0
-0.8
-0.6
-0.02
-0.02
-0.02
2Q07E
3.1
2.6
0.5
0.0
-0.3
2.8
-4.8
-1.5
-2.4
-1.0
0.0
-0.2
-2.0
-1.8
-1.3
0.7
0.0
-1.3
-0.1
-1.2
-1.0
-0.04
-0.04
-0.04
3Q07E
3.5
2.7
0.8
0.0
-0.4
3.1
-4.8
-1.8
-2.1
-0.9
0.0
-0.2
-1.7
-1.5
-1.0
0.5
0.0
-1.1
0.0
-1.1
-0.9
-0.03
-0.03
-0.03
4Q07E
3.6
2.7
0.8
0.0
-0.4
3.2
-4.6
-1.8
-2.0
-0.8
0.0
-0.2
-1.4
-1.2
-0.7
0.4
0.0
-1.0
0.0
-1.0
-0.8
-0.03
-0.03
-0.03
1Q08E
3.7
2.7
0.8
0.1
-0.5
3.2
-4.2
-1.5
-2.0
-0.7
0.0
-0.2
-1.0
-0.8
-0.2
0.5
0.0
-0.4
0.0
-0.4
-0.2
-0.01
-0.01
-0.01
2Q08E
3.7
2.7
0.8
0.1
-0.5
3.3
-3.9
-1.2
-2.0
-0.7
0.0
-0.2
-0.6
-0.4
0.1
0.5
0.0
-0.1
0.0
-0.1
0.1
0.00
0.00
0.00
3Q08E
3.8
2.8
0.8
0.1
-0.5
3.3
-3.7
-1.1
-1.9
-0.8
0.0
-0.2
-0.4
-0.2
0.4
0.5
0.0
0.1
0.0
0.0
0.2
0.00
0.00
0.00
4Q08E
3.8
2.8
0.8
0.2
-0.5
3.3
-3.7
-1.0
-1.9
-0.8
0.0
-0.2
-0.3
-0.1
0.5
0.5
0.0
0.2
0.0
0.2
0.4
0.00
0.00
0.00
FY05
29.3
24.9
4.4
0.1
-2.3
27.0
-10.6
-3.2
-6.0
-1.4
-0.1
0.0
16.4
16.4
17.1
2.2
0.1
18.6
-0.1
18.5
18.5
0.54
0.53
0.52
FY06
19.3
14.7
4.6
0.0
-2.1
17.2
-13.7
-1.7
-8.3
-3.8
1.4
-1.3
3.5
4.8
5.9
2.4
0.0
5.9
-0.1
5.8
7.1
0.17
0.17
0.16
FY07E
13.0
10.3
2.7
0.0
-1.4
11.6
-18.1
-6.0
-8.6
-3.6
0.8
-0.8
-6.6
-5.8
-3.9
2.3
0.1
-4.2
0.1
-4.1
-3.3
-0.12
-0.12
-0.12
FY08E
15.0
11.0
3.4
0.6
-1.9
13.1
-15.5
-4.7
-7.8
-3.0
0.8
-0.8
-2.4
-1.6
0.8
2.0
0.0
-0.3
0.0
-0.3
0.5
-0.01
-0.01
-0.01
0.09
0.07
0.05
-0.01
-0.02
-0.03
-0.03
-0.02
-0.01
0.00
0.01
0.01
0.52
0.20
-0.09
0.01
94.6
47.1
50.8
47.1
54.6
92.4
40.7
45.9
45.3
50.9
95.1
28.6
36.6
37.2
45.3
72.0
-27.9
-21.3
-17.5
-11.6
88.3
-45.0
-30.3
-28.4
-21.3
91.7
-57.3
-43.0
-39.9
-33.4
88.0
-42.0
-28.4
-30.8
-25.1
88.2
-34.8
-20.6
-27.0
-21.4
87.4
-20.6
-6.1
-11.6
-6.2
87.4
-11.6
3.7
-3.2
2.1
87.5
-6.5
9.4
1.3
6.6
87.5
-3.5
13.1
4.0
9.2
92.0
55.9
58.1
63.2
63.2
88.9
24.7
30.7
30.0
36.7
89.0
-44.3
-30.2
-31.4
-25.3
87.5
-10.5
5.1
-2.3
3.0
-6.4
-3.9
9.7
-12.5
-1.3
-15.0
-1.6
-17.3
-19.3
-28.5
-20.8
-22.9
-20.1
-22.6
-26.6
-24.5
-48.5
-40.5
-34.7
-39.8
-34.6
21.6
-8.0
-218.5
-160.3
-131.1
-157.4
-131.2
-37.1
-22.9
1.5
-7.0
15.2
3.4
17.0
10.1
14.3
40.4
65.2
73.1
54.1
72.4
12.8
8.3
-17.3
-12.9
-15.2
-12.9
-15.3
2.0
2.2
-15.6
-10.8
-13.1
-10.8
-13.3
3.1
2.1
-38.9
-56.1
-70.0
-55.6
-70.0
1.1
1.1
-43.3
-73.8
-134.6
-72.1
-134.5
1.1
1.1
-43.1
-154.5
213.3
-141.5
212.7
1.0
1.1
-46.2
171.4
41.1
205.2
40.9
20.5
13.4
-2.7
6.5
14.6
-9.4
-34.1
-36.3
-70.9
-68.2
-61.8
-68.6
-61.4
-32.7
-32.6
n.m.
n.m.
n.m.
n.m.
n.m.
15.2
13.2
n.m.
n.m.
n.m.
n.m.
n.m.
Source: Company, JPMorgan estimates.
283
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 187: Ninetowns Annual Balance Sheet
US$ in millions, year-end December
Cash, cash equivalents and term deposits
Account receivables
Inventory
Total other current assets
Total current assets
Gross fixed assets
Accumulated depreciation
Net fixed assets
Other long term assets
Long term investments and associates
Total long term assets
Total assets
FY05
114.8
5.8
0.9
5.4
126.8
5.0
(0.9)
4.1
33.6
37.7
164.6
FY06
114.2
2.8
0.9
7.0
124.8
7.5
(1.6)
5.9
41.4
47.3
172.2
FY07E
86.3
3.9
1.0
4.4
95.6
11.7
(2.8)
8.9
70.0
78.8
174.5
FY08E
82.9
4.2
1.0
5.0
93.2
15.9
(4.4)
11.4
70.0
81.4
174.5
ST debt and current portion of LT debt
Accounts payable
Other current liabilities
Total current liabilities
Long term debt
Other long term liabilities
Total long term liabilities
Share capital
Share premium
Other reserves
Retained earnings
Preferred stock
Total equity
3.8
8.3
12.1
0.1
0.1
0.1
104.3
48.0
152.4
4.3
3.3
7.6
0.1
109.8
54.7
164.6
2.7
4.1
6.8
0.2
0.2
0.1
114.4
52.9
167.5
0.8
4.3
5.2
0.2
0.2
0.1
116.5
52.6
169.2
Total liabilities and equity
164.6
172.2
174.5
174.5
US$ in millions, year-end December
Net income
Add non cash expenses/(income)
Depreciation and amortization
Extraordinaries
Other non-cash items
Changes in working capital:
(Increase)/decrease receivables
(Increase)/decrease inventories
(Increase)/decrease other current assets
Increase/(decrease) payables
Increase/(decrease) other current liabilities
Net cash from operations
FY05
18.5
0.6
0.1
2.6
0.0
(0.8)
(0.9)
(2.4)
17.9
FY06
5.8
1.2
1.2
3.8
0.1
(1.6)
0.0
(5.4)
5.1
FY07E
(4.1)
1.8
0.8
(1.1)
(0.1)
2.8
(1.7)
0.7
(0.8)
FY08E
(0.3)
2.3
0.8
(0.3)
(0.1)
(0.6)
(1.9)
0.3
0.2
Purchase of property, plant & equipment
Purchase/sale of other LT assets
Purchase/sale of investments
Net cash from investing activities
(6.7)
(6.9)
(13.6)
-
(2.5)
(2.2)
(17.5)
(22.3)
-
(3.9)
(28.1)
(32.1)
-
(4.1)
(0.7)
(4.9)
-
(0.7)
0.9
0.2
(0.4)
4.2
6.9
102.4
114.8
(0.1)
0.9
0.8
(0.4)
(16.8)
12.6
114.8
114.2
0.2
0.9
0.8
1.9
(30.9)
114.2
86.3
1.3
0.0
1.3
(3.4)
86.3
82.9
Source: Company reports, JPMorgan estimates.
Table 188: Ninetowns Annual Cash Flow Statement
Issuance/repayment of debt
Change in other LT liabilities
Change in common equity - net
Payment of cash dividends
Other financing charges, net
Net cash from financing activities
Net effect of exchange rate changes
Net change in cash and cash equivalents
Net change in term deposits
Total cash balance at beginning of period
Total cash balance at end of period
Source: Company reports, JPMorgan estimates.
284
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Shanda, Overweight ($34.39)
We maintain our Overweight rating on Shanda, which also remains our top pick in
the China online games sector. We maintain our view that: (1) Industry-wide online
gamers shift from pay-to-play paying model to free-to-play (item sales) paying
model will benefit Shanda, the largest free-to-play online game operator in China. (2)
Shanda’s strong marketing capability and operating platform should enable it to
further monetize its aging, but very well known games Mir2 and Woool.
•
Shanda continues to execute in a consistently solid vein. In 3Q07, the strong
execution drove record-high active paying accounts (APA) of 3.08 million (in
the MMORPG segment), up 13%Q/Q; growth came mainly from existing game
titles (such as Woool and Mir2), with small contributions from new game Feng
Yun Online (acquired in July). The solid 3Q07 result again gives us confidence
that Shanda can maintain good growth on its existing games by providing
quality upgrades and ongoing promotions through its game platform. Further, we
believe the company’s focus on expanding APA (as against ARPU) should be
positive for Shanda in the long run.
•
We also maintain our view that Shanda’s strong marketing capability and proven
operating platform should enable it to further monetize its aging, but still popular
games Mir2 and Woool. We believe new gamers in lower-tier cities are likely to
continue adopting them (due to their famous brand name); further, upgrade
packs should continue to draw old gamers back.
•
Shanda currently operates around 20 games, and also has a very healthy game
pipeline with around 9 MMOGS (including several 2.75D / 3D games) and 9
casual games for 4Q07/2008. Shanda targets launching 1 or 2 big hit titles each
year, and we expect the next big game to be Changchun Online – to be launched
in 1H08.
•
In our view, share price drivers in the near to medium term include: (1)
operating results of new games such as Changchun Online (testing) and DDO in
4Q07; (2) continued good execution likely to lead to earnings upside.
•
For 4Q07, we forecast net revenue at US$92.3M, up 6% Q/Q and 53% Y/Y, and
GAAP diluted EPS of US$0.44, down 1% Q/Q but up 41% Y/Y, or adjusted
EPS (ex-share-based expense) of US$0.46, down 1% Q/Q but up 41% Y/Y.
Sequential revenue growth is in the mid-range of company guidance of 4% - 7%
Q/Q growth. We expect MMORGP revenue to be up ~6.5% Q/Q, on the back of
momentum of new game Feng Yun Online and other game updates. For casual
games, we forecast revenue growth of ~3.4% QoQ (on weak 4Q seasonality).
285
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 189: Shanda Financial Snapshot
US$ millions, except per share data
4Q07E 3Q07A 4Q06A
JPMorgan
Revenue
EBITDA
EPS (GAAP)
EPS (Adj.) *
Consensus
Revenue
EBITDA
EPS (GAAP)
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
92.3
45.3
0.44
0.46
87.4
44.1
0.44
0.46
60.3
25.9
0.31
0.33
53%
75%
41%
41%
6%
3%
-1%
-1%
322.2
164.3
1.66
1.76
399.9
197.3
1.76
1.85
483.6
242.1
2.12
2.21
54%
133%
80%
101%
24%
20%
6%
5%
21%
23%
20%
19%
89.1
0.46
87.4
44.1
0.44
60.3
25.9
0.31
48% 2%
48% 5%
318.9
1.77
393.3
1.93
447.6
2.26
53%
92%
23%
9%
14%
17%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense. 4Q06A EPS figures also
exclude gain from sale of Sina shares.
Our Estimates and Outlook for 2008
We forecast 2008 net revenue of US$399.9M, up 24% Y/Y, and GAAP-diluted EPS
of US$1.76, up 6% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.85, up
5% Y/Y (lower earnings growth on account of higher operating expenses and higher
tax rate assumption) . We expect the top line to be driven by 27% Y/Y growth in
MMORPG revenue (~85% of total revenues) and 13% Y/Y growth in casual games
revenue. In respect of the new in-game advertising business, we believe it is still in
the phase of technology development for ad placement solutions; some revenue
contribution may start in mid-2008, probably around the Olympics with ads on sports
casual games.
On margins, we forecast gross margin at 66.3% for 2008, down modestly from
67.6% for 2007; adjusted operating margin (ex-share-based expense) of 39.0% for
2008, down from 42.9% for 2007 (due to higher SG&A and R&D expenses), and
adjusted net margin (ex-share-based expense) of 35.0% for 2008, down from 40.2%
for 2007 (partially due to slightly higher tax rate assumption for 2008).
Our Estimates and Outlook for 2009
For 2009, we forecast net revenue at US$483.6M, up 21% Y/Y, and GAAP diluted
EPS of US$2.12, up 20% Y/Y, or adjusted EPS (ex-share-based expense) of
US$2.21, up 19% Y/Y. We forecast 21% Y/Y revenue growth for MMORPG and
20% Y/Y growth for casual games. We forecast gross margin at 65.7% for 2009
(stable Y/Y); adjusted operating margin (ex-share-based expense) of 39.1% (stable
Y/Y) and adjusted net margin of 34.8% (also stable).
Rating and Price Target
We maintain our Overweight stance on Shanda, on the back of: (1) Industry-wide
online gamers shift to free-to-play (item sales) model will benefit Shanda, the largest
free-to-play online game operator in China. (2) Shanda’s strong marketing capability
and operating platform will enable it to further monetize its aging, but very well
known games Mir2 and Woool, (3) consistent solid execution, and (4) Shanda
continues to expand its game pipeline and diversifies game-specific risks.
Our Dec-08 price target is US$43, which implies 24.4x 2008E and 20.3x 2009E
diluted GAAP EPS, or 23.2x 2008E and 19.5x 2009E adjusted diluted EPS (ex-
286
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
share-based expense). The price target is in line with our DCF valuation of ~US$45
(12% WACC, 0% terminal growth).
Risks to Our Rating and Price Target
Upside risks include: (1) New games such as DDO and Changchun attracting greaterthan-expected user traction; (2) better-than-expected casual game revenue in 2008;
and (3) in-game advertising ahead of our expectations in 2008. On the other hand,
key downside risks include: (1) Existing games seeing a significant decline from lack
of new content or promotion; (2) new big titles in MMORPG seeing lower-thanexpected gamer interest.
287
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 190: Shanda Income Statement
US$ in millions, except per share data, year-end December
Revenue
MMORPG
Casual games
EZ hardware
EZ subscription
Others
COGS
Gross Profit
Operating Expense
Sales & Mktg. expenses
G&A expenses
R&D expenses
Other expenses
123R share-based comps.
EBIT
Adj. EBIT (ex-123R expense)
EBITDA
Net Interest Income
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Net Profit (Reported)
Adj. Net Profit (ex-123R exp.) *
Pre Tax EPS (US$)
After Tax EPS (US$)
Diluted EPS (Reported, US$)
Adj. Diluted EPS (US$, ex-123R)
Margins (%)
Gross Margin
Operating Margin (ex-123R exp.)
EBITDA Margin
Net Margin
Adj. Net Margin (ex-123R exp.)
Sequential Growth (%)
Revenue
Gross Profit
Adj. EBIT
Pre Tax Profit
Net Profit (ex-123R exp.)
Diluted EPS
Adj. Diluted EPS (ex-123R exp.)
Source: Company, JPMorgan estimates.
288
1Q06
42.6
28.1
10.5
1.4
0.0
2.6
-18.4
24.2
-21.9
-8.0
-7.3
-6.6
0.0
-1.5
2.3
3.8
8.6
0.1
1.4
3.7
1.1
1.5
3.0
0.05
0.02
0.02
0.04
2Q06
50.7
38.1
8.7
1.1
0.0
2.8
-22.1
28.7
-17.2
-4.9
-6.5
-5.9
0.0
-0.8
11.4
12.2
16.3
0.1
6.3
17.9
0.3
16.7
17.5
0.25
0.23
0.23
0.24
3Q06
55.2
42.0
9.7
0.9
0.0
2.6
-24.2
31.0
-16.8
-4.0
-8.2
-4.5
0.0
-1.4
14.2
15.6
20.0
0.2
6.1
20.5
2.0
18.1
19.5
0.29
0.25
0.25
0.27
4Q06
60.3
48.4
9.2
0.0
0.0
2.6
-22.3
37.9
-18.1
-5.8
-8.1
-4.1
0.0
-1.4
19.9
21.3
25.9
0.5
12.4
32.8
1.3
30.8
23.6
0.46
0.43
0.42
0.33
1Q07
68.8
53.5
11.8
0.9
0.0
2.6
-24.0
44.9
-15.8
-3.8
-8.4
-3.6
0.0
-1.5
29.0
30.5
36.0
0.9
33.3
63.2
3.1
58.0
27.8
0.88
0.81
0.79
0.38
2Q07
74.1
62.1
9.3
0.0
0.0
2.7
-24.3
49.8
-17.8
-5.0
-8.7
-4.0
0.0
-2.0
32.1
34.1
39.4
1.1
26.4
59.6
5.0
54.6
33.3
0.84
0.76
0.74
0.46
3Q07
87.4
73.4
10.9
0.1
0.0
3.0
-26.4
61.0
-26.6
-8.1
-11.9
-6.6
0.0
-2.0
34.3
36.3
44.1
2.0
2.7
39.1
6.4
31.8
33.8
0.55
0.44
0.44
0.46
4Q07E
92.3
78.2
11.3
0.1
0.0
2.7
-29.9
62.3
-26.8
-7.4
-12.0
-7.4
0.0
-1.7
35.6
37.3
45.3
3.6
0.9
40.1
6.3
32.8
34.5
0.55
0.45
0.44
0.46
1Q08E
95.9
81.3
11.8
0.1
0.0
2.7
-31.2
64.7
-27.8
-7.7
-12.5
-7.7
0.0
-1.7
36.9
38.6
47.1
1.9
1.0
39.8
6.2
32.5
34.3
0.55
0.45
0.43
0.46
2Q08E
98.6
83.6
12.0
0.1
0.0
3.0
-32.9
65.7
-28.6
-7.9
-12.8
-7.9
0.0
-1.7
37.1
38.8
48.6
2.2
1.0
40.3
6.3
33.0
34.7
0.56
0.46
0.44
0.46
3Q08E
101.4
85.8
12.4
0.1
0.0
3.2
-35.1
66.4
-29.4
-8.1
-13.2
-8.1
0.0
-1.7
36.9
38.7
50.2
2.4
1.0
40.4
6.3
33.1
34.8
0.56
0.46
0.44
0.46
4Q08E
103.9
87.9
12.8
0.1
0.0
3.2
-35.7
68.2
-30.1
-8.3
-13.5
-8.3
0.0
-1.7
38.1
39.8
51.5
2.7
1.0
41.8
6.5
34.3
36.0
0.58
0.47
0.45
0.48
FY06
208.6
156.3
38.2
3.5
0.0
10.6
-87.0
121.6
-74.0
-22.8
-30.0
-21.2
0.0
-5.0
47.6
52.6
70.5
0.9
26.0
74.5
-4.6
66.7
63.3
1.05
0.94
0.92
0.88
FY07E
322.2
266.8
43.3
1.1
0.0
11.0
-104.5
217.7
-86.8
-24.2
-41.0
-21.6
0.0
-7.2
130.9
138.1
164.3
7.6
64.0
202.4
-20.7
177.8
129.3
2.82
2.48
2.42
1.76
FY08E
399.9
338.6
49.0
0.2
0.0
12.1
-134.9
265.0
-116.0
-32.0
-52.0
-32.0
0.0
-6.9
149.0
156.0
197.3
9.2
4.0
162.2
-25.4
132.9
139.8
2.25
1.84
1.76
1.85
FY09E
483.6
410.4
59.0
0.3
0.0
13.9
-166.1
317.5
-135.4
-38.7
-58.0
-38.7
0.0
-6.9
182.1
189.0
242.1
13.8
4.8
200.7
-31.1
161.6
168.5
2.76
2.22
2.12
2.21
56.8
8.9
20.1
3.5
7.0
56.5
24.0
32.1
32.9
34.4
56.2
28.3
36.2
32.9
35.4
62.9
35.3
43.0
51.1
39.2
65.2
44.3
52.3
84.3
40.5
67.2
46.0
53.2
73.7
44.9
69.8
41.6
50.5
36.4
38.7
67.6
40.4
49.1
35.5
37.4
67.5
40.3
49.1
33.9
35.7
66.6
39.4
49.3
33.4
35.2
65.4
38.1
49.4
32.6
34.3
65.6
38.3
49.6
33.0
34.7
58.3
25.2
33.8
32.0
30.4
67.6
42.9
51.0
55.2
40.2
66.3
39.0
49.3
33.2
35.0
65.7
39.1
50.1
33.4
34.8
-4.7
-9.7
n.m.
56.6
n.m.
n.m.
n.m.
19.1
18.6
221.0
377.4
489.0
1,036.0
489.1
8.8
8.2
28.2
14.6
11.8
8.2
11.4
9.1
22.2
36.2
59.9
21.0
69.0
20.6
14.2
18.3
43.3
92.7
17.9
87.5
17.2
7.7
11.1
11.7
-5.7
19.5
-5.7
19.8
17.9
22.3
6.7
-34.4
1.6
-40.5
1.1
5.6
2.2
2.6
2.4
2.1
-1.0
-0.7
4.0
3.8
3.6
-0.7
-0.7
-0.6
-0.5
2.8
1.5
0.6
1.3
1.3
1.0
1.0
2.9
1.0
-0.5
0.3
0.3
0.0
0.0
2.5
2.8
3.0
3.6
3.5
3.4
3.2
-10.1
-22.4
-30.8
-23.9
213.4
232.0
215.2
54.5
79.0
162.3
171.6
104.2
161.8
100.7
24.1
21.8
12.9
-19.9
8.1
-27.1
5.4
20.9
19.8
21.2
23.7
20.5
20.2
19.2
* Note: Adjusted net profit for 4Q06, 1Q07 and 2Q07 also excludes gain from Sina stake sale.
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 191: Shanda Annual Balance Sheet
US$ in millions, year-end December
Cash and Cash Equivalents
Account Receivables
Inventory
Total Other Current Assets
Total Current Assets
Gross Fixed Assets
Accumulated Depreciation
Net Fixed Assets
Other Long Term Assets
Long Term Investments and Associates
Total Long Term Assets
Total Assets
FY06
162.9
4.0
1.1
12.2
180.2
63.8
(19.8)
44.0
98.3
326.1
468.5
648.6
FY07E
250.7
6.0
0.5
18.2
275.4
81.2
(40.8)
40.4
187.9
119.9
348.2
623.6
FY08E
390.0
6.8
0.6
21.4
418.7
115.4
(60.2)
55.2
190.0
121.2
366.4
785.2
FY09E
575.2
8.5
0.7
26.1
610.6
155.4
(86.3)
69.1
190.0
121.2
380.3
990.8
ST Debt and Current Portion of LT Debt
Accounts Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Long Term Liabilities
Total Long Term Liabilities
Share Capital
Share Premium
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
270.7
11.5
61.3
343.5
0.4
0.4
1.5
185.2
43.8
74.3
304.8
8.5
121.7
130.2
24.9
24.9
1.6
204.3
22.2
240.5
468.5
10.0
138.6
148.6
17.6
17.6
1.6
219.0
22.4
376.0
619.0
12.2
173.3
185.5
12.3
12.3
1.6
231.5
22.4
537.5
793.0
Total Liabilities and Equity
648.6
623.6
785.2
990.8
Net Income
Add Non cash Expenses/(income)
Depreciation and Amortization
Extraordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
FY06
66.7
17.8
3.2
5.0
6.2
2.5
(1.8)
3.3
(7.3)
95.6
FY07E
177.8
26.2
3.9
7.2
(1.8)
0.7
(5.5)
(3.5)
57.6
262.7
FY08E
132.9
41.4
4.0
6.9
(0.8)
(0.1)
(3.0)
1.4
15.6
198.3
FY09E
161.6
53.0
8.0
6.9
(1.7)
(0.1)
(4.8)
2.3
34.7
259.8
Purchase of Property, Plant & Equipment
Purchase/Sale of Other LT assets
Purchase/Sale of Investments
Net Cash from Investing Activities
(18.6)
(42.1)
(25.0)
(85.7)
(8.4)
(97.5)
220.8
114.9
(33.3)
(22.5)
(55.7)
(39.9)
(27.0)
(66.9)
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Effect of Exchange Rate Changes
Net Change in Cash and Cash Equivalents
Cash at End of Period
(9.1)
(0.1)
33.4
(10.1)
14.2
24.1
162.9
(282.8)
24.5
(19.9)
(18.9)
(297.1)
80.5
250.7
(7.5)
5.6
(4.0)
(6.0)
136.6
390.0
(5.3)
5.6
(8.0)
(7.7)
185.2
575.2
Source: Company reports, JPMorgan estimates.
Table 192: Shanda Annual Cash Flow Statement
US$ in millions, year-end December
Source: Company reports, JPMorgan estimates.
289
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Sina, Neutral ($45.50)
While we maintain our view that Sina is likely to remain the leading portal in China,
we remain Neutral on the stock. We believe most of the near-term positives have
been factored in the share price, and it will be difficult for the stock to see further
multiple expansion in the near term. In addition, the outlook for the wireless segment
(26% of total revenues in 3Q07) remains relatively uncertain.
•
Sina remains the leader in China’s branded advertising market and its online ad
revenue has continued to show strong growth over the last year (with 40% or
higher growth for ad revenue in each of the last 6 quarters). We believe Sina
continues to be seen by advertisers as the leading online media company in
terms of media influence. As such, leading advertisers generally allocate the
largest portion of their online budget to Sina. We expect the display ad market in
China to grow around 50% Y/Y in 2008 (due to Olympics boost for the ad
market), and we expect Sina to register similar ~ 50% Y/Y growth in its branded
ad segment.
•
However, we maintain our Neutral rating on Sina due to valuation. We believe
most of the near-term positives have been factored in the share price, and it will
be difficult for the stock to see further multiple expansion in the near term. We
would revisit our thesis if there is more clarity on potential for higher-thanexpected online ad (and video ad / blog formats) revenue growth in 2009 and we
get more comfortable with the longer-term ad gross margin level. In addition,
the outlook for the wireless segment (26% of total revenues in 3Q07) currently
remains relatively uncertain.
•
We believe potential positive drivers include: (1) stronger-than-expected
Olympics ad growth, (2) upside from blogs, games, finance, or search channel.
•
For 4Q07, we are forecasting net revenue of US$69.3M, up 8% Q/Q and 23%
Y/Y (vs. guidance of US$68-$70M), and GAAP EPS of US$0.28, down 2%
Q/Q and up 38% Y/Y, or adjusted EPS (ex-share-based expense) of US$0.31,
down 2% Q/Q and up 21% Y/Y. We estimate advertising revenue of US$49.7M
in 4Q07, up 9% Q/Q and 39% Y/Y (at the top end of guidance of US$49-$50M).
Table 193: Sina Financial Snapshot
US$ millions, except per share data
4Q07E 3Q07A 4Q06A
JPMorgan
Revenue
EBITDA
EPS (GAAP)
EPS (Adj.) *
Consensus
Revenue
EBITDA
EPS (Adj.) *
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
69.3
22.1
0.28
0.31
64.3
20.7
0.28
0.32
56.4
15.5
0.20
0.26
23%
42%
38%
21%
8%
7%
-2%
-2%
244.7
74.2
0.96
1.09
339.3
102.0
1.28
1.43
406.8
130.3
1.65
1.80
15%
32%
38%
24%
39%
38%
33%
31%
20%
28%
29%
26%
69.1
0.33
64.3
20.7
0.32
56.4
15.5
0.26
23% 7%
28% 4%
244.8
1.09
333.4
1.50
420.1
1.87
15%
24%
36%
38%
26%
25%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.
290
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Our Estimates and Outlook for 2008
We forecast 2008 net revenue at US$339.3M, up 39% Y/Y, and GAAP diluted EPS
of US$1.28, up 33% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.43, up
31% Y/Y. We expect the top line to be driven by 50% Y/Y growth in advertising
segment revenues (74% of total 2008E revenues), with an expected Olympics boost
for the ad market in China. In terms of major advertising sectors, automobiles, real
estate and IT should remain among the largest, while the financial industry (banks,
insurance companies, etc.) could become one of the top 3 largest ad sectors by mid2008. For the wireless related segment (22% of total 2008E revenues), we are
modeling a modest 7% Y/Y (following a 20% decline in 2007). Among other
revenue (~4% of total 2008E revenues), we currently expect ~US$9M in Googlesearch revenue in 2008.
In terms of margins, we forecast gross margin at 61.9% for 2008, stable from 62.1%
for 2007; adjusted operating margin (ex-share-based expense) of 24.5% for 2008,
also flattish from 24.2% for 2007, and adjusted net margin (ex-share-based expense)
of 25.4% for 2008, slightly lower than 26.7% for 2007.
Our Estimates and Outlook for 2009
For 2009, we forecast net revenue at US$406.8M, up 20% Y/Y, and GAAP-diluted
EPS of US$1.65, up 29% Y/Y, or adjusted EPS (ex-share-based expense) of
US$1.80, up 26% Y/Y. We forecast 23% Y/Y growth in advertising segment (76%
of total 2009E revenues) and 11% growth in wireless segment (20% of total 2009E
revenues). We forecast gross margin at 62.2% for 2009 (stable); adjusted operating
margin (ex-share-based expense) of 26.1% (slight expansion) and adjusted net
margin of 26.8% (slight expansion).
Rating and Price Target
We maintain our Neutral rating on Sina, with a Dec-08 price target of US$48, which
implies 38x 2008E and 29x 2009E GAAP PE, or 34x 2008E and 27x 2009 adjusted
P/E. This is above our DCF valuation of US$32. We believe Sina can trade at this
valuation, given its longer-term earnings growth of around 30% and historical trading
range of 25x-40x forward PE. Our sum-of-the-parts valuation points to a range of
US$44 – US$53; our price target is close to the mid-point of the estimates.
We believe at the current level, the stock may find it difficult to see further multiple
expansion. We would revisit our thesis if we get more clarity on potential for higherthan-expected online ad (and video ad / blog formats) revenue growth in 2009, and
get more comfortable with longer-term ad gross margin level.
Risks to Our Rating and Price Target
Upside risks to our rating and price target include: better-than-expected online
advertising growth, further partnerships formed, and upside from Google-Sina search
partnership. Downside risks include: decline in online ad gross margin, slowdown in
advertising spending in China, competition with other Internet portals, and changes
in regulations in wireless value-added space, as well as further decline in wirelessrelated revenue due to strong competition.
291
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 194: Sina Income Statement
US$ in millions, except per share data, year-end December
Revenue
Mobile related
Advertising
Others
COGS
Gross Profit
Operating Expense
Sales & Mktg. expenses
G&A expenses
R&D expenses
Other expenses
Share-based compensation
EBIT
Adjusted EBIT (ex- 123R exp.)
EBITDA
Net Interest Income
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Reported Net Profit
Adj. Net Profit *
Reported Diluted EPS (US$)
Adj. Diluted EPS (US$) *
Margins (%)
Gross Margin
Adj. Operating Margin *
EBITDA Margin
Net Margin
Adj. Net Margin *
Sequential Growth (%)
Revenue
Gross Profit
Adj. EBIT (ex-123R)
EBITDA
Reported Diluted EPS
Adj. Diluted EPS *
1Q06
46.7
22.7
22.2
1.8
-17.7
29.0
22.4
-11.5
-4.6
-4.3
-0.5
-1.5
6.6
8.1
10.9
1.8
-0.6
7.8
0.8
7.0
9.6
0.12
0.16
2Q06
53.7
22.4
29.5
1.8
-19.3
34.4
26.7
-13.1
-5.5
-4.6
-0.5
-3.0
7.6
10.7
13.5
1.8
1.8
11.3
0.9
10.4
12.3
0.18
0.21
3Q06
56.1
21.8
32.7
1.6
-19.5
36.6
26.2
-11.7
-6.8
-4.5
-0.5
-2.7
10.4
13.1
13.6
2.0
-0.6
11.8
1.1
10.7
14.7
0.19
0.25
4Q06
56.4
19.3
35.7
1.4
-21.2
35.2
25.0
-12.1
-5.9
-4.4
-0.4
-2.2
10.2
12.5
12.9
2.3
0.5
13.0
1.3
11.7
15.2
0.20
0.26
1Q07
51.3
18.2
31.8
1.3
-20.4
30.9
23.4
-10.7
-5.8
-4.3
-0.4
-2.2
7.5
9.7
13.1
2.5
0.0
10.0
1.4
8.6
11.4
0.15
0.19
2Q07
59.8
17.0
41.2
1.6
-22.2
37.6
24.9
-11.7
-6.0
-4.9
-0.3
-2.1
12.7
14.7
18.3
2.4
0.8
15.9
1.5
14.5
16.1
0.25
0.27
3Q07
64.3
16.6
45.8
1.9
-24.1
40.2
25.1
-12.1
-5.5
-5.5
-0.3
-1.7
15.2
16.9
20.7
3.7
0.0
18.9
1.7
17.2
19.1
0.28
0.32
4Q07E
69.3
17.1
49.7
2.4
-26.0
43.3
26.8
-13.2
-6.2
-5.5
-0.3
-1.6
16.4
18.0
22.1
2.5
0.0
18.9
2.1
16.9
18.8
0.28
0.31
1Q08E
65.1
17.7
44.3
3.2
-26.5
38.7
26.4
-13.0
-5.9
-5.2
-0.3
-2.0
12.3
14.3
18.6
2.7
0.0
15.0
1.7
13.3
15.6
0.22
0.26
2Q08E
83.8
18.1
62.4
3.2
-31.5
52.3
33.9
-17.6
-7.5
-6.5
-0.3
-2.0
18.4
20.4
25.0
2.8
0.0
21.2
2.3
18.9
21.1
0.31
0.35
3Q08E
103.0
18.6
81.1
3.3
-38.4
64.6
41.2
-21.6
-9.3
-8.0
-0.3
-2.0
23.4
25.4
30.3
2.9
0.0
26.4
2.8
23.5
25.8
0.39
0.43
4Q08E
87.4
19.1
64.9
3.4
-32.9
54.5
33.5
-16.6
-7.9
-6.8
-0.3
-2.0
21.0
23.0
28.2
3.1
0.0
24.1
2.6
21.5
23.8
0.35
0.39
FY06
212.9
86.3
120.1
6.5
-77.7
135.2
-100.3
-48.5
-22.8
-17.8
-1.8
-9.5
34.9
44.4
56.1
7.9
1.2
44.0
-4.1
39.9
51.7
0.69
0.88
FY07E
244.7
69.0
168.5
7.2
-92.7
152.0
-100.2
-47.6
-23.5
-20.3
-1.2
-7.6
51.8
59.3
74.2
11.1
0.8
63.7
-6.6
57.1
65.4
0.96
1.09
FY08E
339.3
73.5
252.7
13.1
-129.3
210.1
-134.9
-68.9
-30.5
-26.5
-1.0
-8.0
75.2
83.2
102.0
11.6
0.0
86.7
-9.5
77.3
86.3
1.28
1.43
FY09E
406.8
81.7
310.5
14.6
-153.8
252.9
-154.7
-78.1
-36.6
-30.9
-1.0
-8.0
98.2
106.2
130.3
13.9
0.0
112.2
-12.0
100.2
109.2
1.65
1.80
62.1
17.4
23.4
15.1
20.5
64.0
19.8
25.1
19.4
22.9
65.3
23.4
24.2
19.1
26.1
62.4
22.1
22.8
20.8
26.9
60.2
18.9
25.6
16.8
22.1
62.9
24.6
30.6
24.2
26.9
62.5
26.2
32.1
26.7
29.7
62.5
26.0
31.9
24.4
27.1
59.4
22.0
28.5
20.4
23.9
62.4
24.4
29.8
22.6
25.3
62.7
24.7
29.4
22.8
25.0
62.4
26.3
32.3
24.6
27.2
63.5
20.9
26.4
18.8
24.3
62.1
24.2
30.3
23.3
26.7
61.9
24.5
30.1
22.8
25.4
62.2
26.1
32.0
24.6
26.8
-10.1
-0.4
-15.1
-23
-48
14.9
18.4
30.8
23.6
47.7
28.5
4.4
6.4
23.2
0.7
2.7
19.4
0.6
-3.7
-5.1
-20.2
8.5
2.8
-9.1
-3.7
-12.3
-15.6
-26.8
-25.7
16.6
21.8
52.3
39.4
65.5
40.9
7.6
6.9
14.5
13.1
16.2
17.7
7.7
7.6
6.8
6.9
-1.9
-2.1
-6.0
1.7
-10.7
-16.0
-21.2
-17.1
28.6
35.2
42.6
34.5
41.7
35.7
23.0
23.6
24.7
21.4
24.5
21.9
-15.2
-15.6
-9.5
-7.0
-8.8
-8.0
10.0
3.6
6.9
3.4
-7.1
18.3
15.0
12.4
33.7
32.2
38.4
23.6
38.7
38.2
40.2
37.5
33.1
30.7
19.9
20.4
27.7
27.7
29.1
26.0
Source: Company and JPMorgan estimates. * Note: Adjusted for 123R share based compensation expense and other non-cash & non-recurring items.
292
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 195: Sina Annual Balance Sheet
US$ in millions, year-end December
Cash and Cash Equivalents
Account Receivables
Inventory
Total Other Current Assets
Total Current Assets
Gross Fixed Assets
Accumulated Depreciation
Net Fixed Assets
Other Long Term Assets
Long Term Investments and Associates
Total Long Term Assets
Total Assets
FY06
163.2
45.0
199.6
10.3
418.1
64.0
-36.9
27.1
92.4
1.2
120.7
538.8
FY07E
234.2
41.8
199.6
18.5
494.0
84.0
-53.1
30.9
91.2
1.2
123.3
617.3
FY08E
320.8
52.7
199.6
23.3
596.4
110.0
-71.0
39.1
90.2
1.2
130.4
726.8
FY09E
431.8
68.3
199.6
30.2
730.0
140.0
-94.0
46.0
89.1
1.2
136.4
866.3
ST Debt and Current Portion of LT Debt
Accounts Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Long Term Liabilities
Total Long Term Liabilities
Share Capital
Share Premium
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
0.0
1.6
49.4
51.0
100.0
0.0
100.0
7.2
303.9
0.0
76.7
0.0
387.8
0.0
3.7
52.3
55.9
100.0
0.0
100.0
7.3
320.2
0.0
133.8
0.0
461.3
0.0
4.6
66.0
70.6
100.0
0.0
100.0
7.3
337.9
0.0
211.1
0.0
556.3
0.0
5.9
85.5
91.4
100.0
0.0
100.0
7.4
356.3
0.0
311.2
0.0
674.9
Total Liabilities and Equity
538.8
617.3
726.8
866.3
FY06
39.9
FY07E
57.1
FY08E
77.3
FY09E
100.2
11.7
0.0
9.5
14.9
0.0
7.6
18.9
0.0
8.0
24.1
0.0
8.0
-11.1
0.0
2.1
0.0
1.9
54.0
3.3
0.0
-8.1
2.0
2.9
79.6
-10.9
0.0
-4.8
0.9
13.7
103.0
-15.6
0.0
-6.9
1.3
19.6
130.5
Purchase of Property, Plant & Equipment
Purchase/Sale of Other LT assets
Purchase/Sale of Investments
Net Cash from Investing Activities
-14.8
1.3
15.5
2.0
-17.4
0.0
0.0
-17.4
-26.0
0.0
0.0
-26.0
-30.0
0.0
0.0
-30.0
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Effect of Exchange Rate Changes
Net Change in Cash and Cash Equivalents
Cash at End of Period
0.0
0.0
10.0
0.0
8.8
18.8
0.0
0.0
8.9
0.0
0.0
8.9
0.0
0.0
9.7
0.0
0.0
9.7
0.0
0.0
10.5
0.0
0.0
10.5
74.8
163.2
71.0
234.2
86.6
320.8
111.0
431.8
Source: Company reports, JPMorgan estimates.
Table 196: Sina Annual Cash Flow Statement
US$ in millions, year-end December
Net Income
Add Non cash Expenses/(income)
Depreciation and Amortization
Extraordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
Source: Company reports, JPMorgan estimates.
293
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Sohu, Overweight ($56.58)
We maintain our Overweight rating on Sohu, which also remains our top pick in the
brand advertising sector in China. With strong secular growth of online advertising in
China, benefits from Olympics (near term on content due to official Internet
sponsorship, longer term on brand awareness and improved execution), and bonus
from online gaming, we maintain Sohu as our top pick.
294
•
As the official 2008 Beijing Olympics Internet content sponsor, Sohu’s brand
awareness continues to strengthen among Internet users, advertisers and also the
government. Sohu is also a strategic partner for China Interactive Sports (Sohu
builds and hosts their sports site; most of China’s athletes belong to CI Sports
and will host their blogs on Sohu) and an exclusive sponsor for China’s National
Team, or ‘Team China’ (athletes in China’s national teams in international
events such as the Olympics belong to Team China). Through such
sponsorships, Sohu will have access to first interview rights to Chinese athletes
after each Olympics event, and can carry official news for the athletes, during
and around the Olympics time. We expect this to help drive traffic before /
during the Olympics. On the back of such content strength and consistent
execution, we forecast Sohu's branded ad revenue to grow at ~48% Y/Y in 2008
(after 40% Y/Y in 2007) and ~15% in 2009 (conservative estimate).
•
Sohu’s success in online gaming with its game ‘TLBB’ (launched in May-07) is
an added bonus (for revenues and margins) going forward. In 3Q07, the game
saw average paying accounts of 690K, up from 209K in 2Q07; while peak
concurrent users hit 500K in November. We expect TLBB to see sustained
growth in 2008 as well. We believe the strong TLBB result is due to the team’s
deep experience and good understanding of Chinese gamers, and TLBB's strong
brand name. Sohu has also signed another game naming right from TLBB’s
novelist, Jinyong: “The Duke of Mount Deer” will likely be the title of Sohu’s
next in-house game (likely to be launched in late 2008).
•
Positive share price drivers include: 1) As the Olympics draw nearer, Sohu is
likely to benefit from Olympics-related advertising and stronger branding
effects; (2) positive revenue/margin impact from its successful game TLBB; (3)
potential upside from next game “The Duke of Mount Deer” to be launched in
late-08; (4) strong growth in video-related traffic should provide benefit from
increasing ad rates, offsetting higher content costs; and (5) potential upside from
monetization of its social networks.
•
For 4Q07, our revenue forecast is US$55.9M, up 8% Q/Q and 63% Y/Y, and
GAAP EPS of US$0.30, up 20% Q/Q and 89% Y/Y, or adjusted EPS (ex-sharebased expense) of US$0.35, up 15% Q/Q and 66% Y/Y. (Note: Sohu has
increased its 4Q07 revenue guidance to US$55.5–$57.5M, up $2M vs. prior
guidance US$53.5-$55.5M, due to strength in online game TLBB. Adjusted EPS
guidance is US$0.36-$0.38, vs. prior US$0.33-$0.35. We are reviewing our
numbers. )
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 197: Sohu Financial Snapshot
US$ millions, except per share data
4Q07E 3Q07A 4Q06A
JPMorgan
Revenue
EBITDA
EPS (GAAP)
EPS (Adj.) *
Consensus
Revenue
EBITDA
EPS (GAAP)
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
55.9
16.2
0.30
0.35
51.5
13.2
0.25
0.31
34.4
10.0
0.16
0.21
63% 8%
61% 22%
89% 20%
66% 15%
179.5
48.5
0.82
1.05
281.0 319.8
92.3 109.2
1.78 2.17
2.00 2.40
33%
23%
22%
23%
57%
90%
116%
90%
14%
18%
22%
20%
54.7
0.29
51.5
13.2
0.25
34.4
10.0
0.16
59% 6%
80% 14%
179.4
0.83
271.6 341.2
1.52 2.03
34%
22%
51%
83%
26%
34%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.
Our Estimates and Outlook for 2008
Our forecast for 2008 net revenue is US$281.0M, up 57% Y/Y, and GAAP-diluted
EPS of US$1.78, up 116% Y/Y, or adjusted EPS (ex-share-based expense) of
US$2.00, up 90% Y/Y. We forecast 2008 brand advertising revenue of US$164.1M
(58% of total revenues), up 48% Y/Y, and online game revenue of US$78.2M (28%
of total revenues), up 129% Y/Y. In terms of Olympics advertising, Sohu expects the
spending pattern in three phases: (1) 4Q07 till early May - advertisers likely will still
be relatively slow in Olympics-related spending; (2) From May until early August the Olympics torch relay will begin in May, and advertisers will likely increase their
ad spending; (3) During the month of August - the largest ad spending should take
place during the actual Olympics event.
On margins, we forecast gross margin at 69.6% for 2008, expanding from 65.5% for
2007 (boosted by higher-margin online games segment); adjusted operating margin
(ex-share-based expense) of 28.6% for 2008, expanding from 21.3% for 2007, and
adjusted net margin (ex-share-based expense) of 27.7% for 2008, up from 22.5% for
2007.
Our Estimates and Outlook for 2009
For 2009, we forecast net revenue at US$319.8M, up 14% Y/Y, and GAAP-diluted
EPS of US$2.17, up 22% Y/Y, or adjusted EPS (ex-share-based expense) of
US$2.40, up 20% Y/Y. We forecast gross margin at 70.3% for 2009 (up slightly
Y/Y); adjusted operating margin of 30.2% (slight expansion) and adjusted net margin
of 29.8% (slight expansion).
Rating and Price Target
We maintain our OW stance on Sohu, which is also on the LONG side of our
Analyst Focus List. Our Dec-08 price target of US$69 implies 39x 08E and 32x 09E
GAAP EPS, or 35x 08E and 29x 09E adjusted diluted EPS (ex-share-based expense);
the price target is based on mid-point of our sum-of-parts valuation of US$63 US$75.
We believe Sohu would likely see multiple expansion due to: (1) As we approach the
2008 Olympics, Sohu is likely to benefit from Olympics-related advertising and
stronger branding effects. (2) Strong growth in video-related traffic should benefit
Sohu from increasing ad rates, which help offset an increase in content costs. (3)
Positive financial impact (revenue & margins) from online game TLBB. (4) Sohu
295
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
may begin to see meaningful monetization from its social networks (China Ren
alumni site, bulletin boards, etc.).
Risks to Our Rating and Price Target
Risks to our price target include a slowdown in the Chinese economy that could
result in lower online advertising revenue growth, significant market share loss in
online advertising to other portals, and uncertainty in wireless revenue due to policy
change by mobile operators.
296
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 198: Sohu Income Statement
US$ in millions, except per share data, year-end December
Revenue
Advertising
Brand advertising
Paid search
Mobile related
Online games (breakout from 1Q07)
Others
COGS
Gross Profit
Operating Expense
Sales & Mktg. expenses
G&A expenses
R&D expenses
Other expenses
Share-based compensation
EBIT
Adj. EBIT (ex- 123R expense)
EBITDA
Net Interest Income
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Net Profit (after MI)
Adj. Net Profit (ex- 123R exp.)
Diluted EPS (US$)
Adj. Diluted EPS (US$, ex- 123R
exp.)
Margins (%)
Gross Margin
Operating Margin (ex- 123R exp.)
EBITDA Margin
Net Margin
Adj. Net Margin (ex- 123R exp.)
Sequential Growth (%)
Revenue
Gross Profit
EBIT
EBITDA
Diluted EPS
Adj. Diluted EPS
1Q06
31.3
20.1
16.7
3.5
8.0
2Q06
34.1
22.8
19.3
3.5
9.0
3Q06
35.4
23.9
21.0
2.9
8.8
4Q06
34.4
24.9
22.0
2.9
6.8
2Q07
39.0
28.4
26.6
1.7
6.6
3.8
0.2
-14.9
24.1
-19.1
-9.0
-2.7
-4.8
-0.3
-2.4
4.9
7.3
9.6
1.1
-0.1
5.9
0.2
5.7
8.1
0.15
0.21
3Q07
51.5
31.5
29.8
1.7
6.8
12.7
0.5
-16.8
34.8
-25.9
-13.2
-4.3
-6.2
-0.2
-2.0
8.8
10.8
13.2
0.6
0.6
10.0
0.3
9.7
11.7
0.25
0.31
4Q07E
55.9
32.3
30.7
1.7
7.5
16.0
0.1
-17.4
38.5
-26.9
-14.2
-3.6
-6.7
-0.4
-1.9
11.6
13.5
16.2
0.5
0.0
12.1
0.4
11.7
13.6
0.30
0.35
1Q08E
59.4
33.9
32.2
1.7
7.6
17.8
0.1
-18.3
41.1
-27.1
-13.4
-4.2
-7.1
-0.4
-2.1
13.9
16.0
18.8
0.6
0.0
14.5
1.2
13.4
15.5
0.35
0.40
2Q08E
73.9
46.8
45.1
1.7
7.8
19.2
0.1
-22.5
51.4
-33.0
-16.6
-5.2
-8.9
-0.3
-2.1
18.4
20.5
23.7
0.7
0.0
19.1
1.5
17.6
19.7
0.45
0.51
3Q08E
79.6
51.3
49.6
1.7
8.0
20.2
0.1
-24.2
55.4
-34.0
-16.7
-5.6
-9.6
-0.1
-2.1
21.4
23.5
26.7
0.9
0.0
22.3
1.7
20.6
22.7
0.53
0.58
4Q08E
68.1
39.0
37.2
1.8
8.1
21.0
0.1
-20.4
47.8
-29.5
-14.3
-4.8
-8.2
-0.1
-2.1
18.3
20.4
23.2
1.1
0.0
19.4
1.5
17.9
20.0
0.46
0.51
FY06
135.1
91.8
79.0
12.8
32.6
2.7
-12.1
22.2
-16.5
-7.4
-2.1
-4.4
-0.5
-2.0
5.7
7.7
10.0
0.9
-0.1
6.5
0.5
6.1
8.1
0.16
0.21
1Q07
33.1
25.6
23.5
2.1
5.6
1.6
0.3
-12.8
20.2
-16.2
-6.8
-2.6
-3.9
-0.4
-2.5
4.1
6.6
9.1
0.8
-0.1
4.7
0.3
4.5
7.0
0.12
0.18
3.1
-10.5
20.8
-14.7
-6.1
-2.7
-3.8
-0.5
-1.7
6.0
7.8
9.6
0.5
-0.1
6.5
0.4
6.0
7.8
0.16
0.20
2.3
-12.2
21.9
-15.3
-6.7
-2.9
-3.9
-0.5
-1.3
6.6
7.8
9.7
0.8
0.1
7.5
0.3
7.2
8.4
0.19
0.22
2.7
-12.0
23.4
-17.3
-6.8
-3.5
-4.5
-0.5
-1.9
6.1
8.0
10.0
1.0
-0.1
7.0
0.4
6.6
8.5
0.17
0.22
66.4
24.8
30.6
19.3
24.9
64.3
23.0
28.5
21.0
24.8
2.6
3.5
33.4
32.8
-32.2
-13.4
9.0
5.6
1.1
1.7
18.9
9.1
10.7
-46.8
88.3
-63.9
-27.1
-11.2
-16.7
-2.0
-6.9
24.4
31.4
39.3
3.2
-0.2
27.5
-1.6
25.9
32.8
0.68
0.86
FY07E
179.5
117.9
110.6
7.2
26.5
34.1
1.0
-61.9
117.6
-88.1
-43.3
-13.1
-21.6
-1.3
-8.8
29.5
38.3
48.5
2.9
0.3
32.7
-1.2
31.5
40.3
0.82
1.05
FY08E
281.0
171.0
164.1
6.8
31.5
78.2
0.3
-85.3
195.6
-123.7
-61.0
-19.7
-33.7
-0.9
-8.4
72.0
80.4
92.3
3.3
0.0
75.3
-5.9
69.4
77.8
1.78
2.00
FY09E
319.8
195.8
188.1
7.7
34.3
89.4
0.3
-95.0
224.8
-137.4
-67.2
-22.4
-38.4
-0.3
-9.2
87.4
96.6
109.2
6.0
0.0
93.4
-7.2
86.2
95.4
2.17
2.40
66.1
22.7
28.4
18.6
24.1
64.7
22.6
29.2
17.7
23.5
61.2
19.8
27.6
13.5
21.0
61.7
18.8
24.6
14.6
20.8
67.5
21.0
25.7
18.8
22.7
68.9
24.2
29.0
20.9
24.3
69.1
27.0
31.6
22.5
26.0
69.6
27.7
32.0
23.8
26.7
69.6
29.5
33.6
25.8
28.5
70.1
30.0
34.0
26.3
29.3
65.4
23.2
29.1
19.2
24.3
65.5
21.3
27.0
17.6
22.5
69.6
28.6
32.9
24.7
27.7
70.3
30.2
34.2
27.0
29.8
3.9
6.8
2.6
3.3
-7.0
2.1
-3.0
-5.1
-3.7
-0.2
-6.9
-4.6
-3.7
-8.9
-15.3
-9.1
-27.1
-14.8
17.8
18.9
11.7
5.1
26.6
15.9
32.1
44.5
47.9
32.4
70.9
46.1
8.4
10.8
24.9
22.4
19.6
15.1
6.3
6.6
18.4
16.1
13.8
13.3
24.4
25.2
27.6
25.9
30.7
26.5
7.8
7.8
14.8
12.9
16.2
14.5
-14.4
-13.8
-13.1
-13.3
-13.4
-12.3
24.7
22.6
25.9
24.0
-11.9
11.1
32.9
33.1
22.0
23.3
21.6
22.9
56.6
66.4
110.0
90.4
116.3
90.0
13.8
14.9
20.2
18.3
21.5
20.0
Source: Company and JPMorgan estimates. * Adjustments: excluding share-based compensation expense.
297
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 199: Sohu Annual Balance Sheet
US$ in millions, year-end December
Cash and Cash Equivalents
Account Receivables
Inventory
Total Other Current Assets
Total Current Assets
Gross Fixed Assets
Accumulated Depreciation
Net Fixed Assets
Other Long Term Assets
Long Term Investments and Associates
Total Long Term Assets
Total Assets
FY06
124.8
23.8
0.0
10.9
159.5
41.4
-19.9
21.5
71.4
1.3
94.1
253.6
FY07E
80.3
33.7
0.0
22.3
136.4
91.9
-28.9
63.0
69.5
0.0
132.5
268.9
FY08E
165.2
41.1
0.0
27.3
233.6
111.9
-40.0
71.9
68.6
0.0
140.5
374.1
FY09E
264.3
52.4
0.0
34.8
351.4
137.9
-52.3
85.6
68.3
0.0
153.9
505.3
ST Debt and Current Portion of LT Debt
Accounts Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Long Term Liabilities
Total Long Term Liabilities
Share Capital
Share Premium
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
59.8
1.2
36.6
97.6
0.0
0.1
0.1
0.0
111.4
0.0
44.5
0.0
156.0
0.0
2.0
55.9
57.9
1.3
0.0
1.3
0.0
133.7
0.0
76.0
0.0
209.8
0.0
2.3
68.1
70.5
1.3
0.0
1.3
0.0
156.9
0.0
145.4
0.0
302.4
0.0
3.0
86.9
89.9
1.3
0.0
1.3
0.0
182.5
0.0
231.6
0.0
414.2
Total Liabilities and Equity
253.6
268.9
374.1
505.3
FY06
25.9
FY07E
31.5
FY08E
69.4
FY09E
86.2
8.0
0.0
6.9
0.0
-4.5
0.0
2.7
-0.5
3.2
41.7
10.2
0.0
8.8
0.0
-9.8
0.0
-11.4
0.8
19.2
49.3
12.0
0.0
8.4
0.0
-7.4
0.0
-4.9
0.3
12.3
90.1
12.6
0.0
9.2
0.0
-11.3
0.0
-7.5
0.6
18.8
108.6
Purchase of Property, Plant & Equipment
Purchase/Sale of Other LT assets
Purchase/Sale of Investments
Net Cash from Investing Activities
-11.7
-7.5
4.7
-14.4
-50.5
0.6
1.3
-48.6
-20.0
0.0
0.0
-20.0
-26.0
0.0
0.0
-26.0
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Change in Cash and Cash Equivalents
Cash at End of Period
-15.0
0.1
-6.7
0.0
0.0
-21.6
5.7
124.8
-58.5
-0.1
13.5
0.0
0.0
-45.1
-44.4
80.3
0.0
0.0
14.8
0.0
0.0
14.8
84.9
165.2
0.0
0.0
16.4
0.0
0.0
16.4
99.0
264.3
Source: Company reports, JPMorgan estimates.
Table 200: Sohu Annual Cash Flow Statement
US$ in millions, year-end December
Net Income
Add Non cash Expenses/(income)
Depreciation and Amortization
Extraordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
Source: Company reports, JPMorgan estimates.
298
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
The9, Overweight ($23.50)
We maintain Overweight on The9, as the company has one of the most diversified
game pipelines, and we believe the risk is on the upside for the company to operate
these games well, despite muted success in the recent two game launches. In
addition, the company is trading at a relatively lower valuation compared with other
online game companies. However, shares could trade flattish in the near term, on the
back of increasing costs and uncertainties (timing, upfront fee, royalty payment) in
WoW (World of Warcraft) renewal terms.
•
We expect WoW to see solid revenue growth in 4Q07 (full quarter impact of
Burning Crusade expansion pack launch) and continue with healthy growth over
the next few quarters, driven by further penetration to lower-tier cities (as more
PCs in lower-tier cities are upgraded with more 3D games in the market).
However, The9 may continue to see more margin pressure going forward,
mainly due to: (1) Loose control on marketing spending in recent times; (2)
year-end bonus and professional fees; (3) The9 may see a slightly higher tax rate
in 2008 and beyond; and (4) second-term WoW license renewal (current license
expires in June 2009) will likely cause reduction in gross margin (from both
amortization of upfront licensing fee and increased ongoing royalty).
•
The9 still has one of the most diversified game pipelines in China online
gaming: 3D games GE and Guild Wars (likely commercialization 1Q08), EA’s
casual soccer game FIFA Online (likely commercialization 3Q08), Hellgate:
London (likely commercialization 1H08) and several others likely in 2H08 (inhouse games FM Online and MJSG, dancing game Audition 2, first-personshooting game Huxley). We believe the risk is on the upside for the company to
operate these games well, despite muted success in the last two game launches
(SUN commercialization and Guild Wars beta testing).
•
We believe positive share price drivers could come around mid-2008 with: (1)
FIFA Online launch; and (2) confirmation of WoW license renewal (current
license expires in June 2009). We do note that with a new corporate structure at
Activision-Blizzard (following the recent merger announcement), there could be
delays in the license renewal process. As such, this could be a drag on The9's
share price. However, we maintain that The9 is the most likely candidate for the
renewal contract, as it has already invested more than US$60 million in WoW
servers - a high entry barrier for other potential licensees.
•
For 4Q07, we forecast net revenue of US$50.9M, up 21% Q/Q and 40% Y/Y,
and GAAP EPS of US$0.18, up 6% Q/Q and down 67% Y/Y, or adjusted EPS
(ex-share-based expense) of US$0.27, up 7% Q/Q and down 54% Y/Y. In
addition to a full quarter of Burning Crusade revenue impact, WoW plans to
launch version 2.3 upgrade during 4Q07 and also launch a new fee-based
character transfer feature that should lead to additional monetization (we expect
these drivers to lead to 4Q07 WoW ACU of 417k and PCU of 910k). However,
margins will likely remain under pressure on higher operating expenses.
299
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 201: The9 Financial Snapshot
US$ millions, except per share data
4Q07E 3Q07A 4Q06A
JPMorgan
Revenue
EBITDA
EPS (GAAP)
EPS (Adj.) *
Consensus
Revenue
EBITDA
EPS (GAAP)
Y/Y Q/Q
F'07E
F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y
50.9
16.4
0.18
0.27
42.2
15.6
0.17
0.25
36.2
16.5
0.54
0.58
40%
-1%
-67%
-54%
21%
5%
6%
7%
163.2
61.7
0.93
1.17
248.9
100.0
1.26
1.60
318.8
139.1
1.84
2.18
31%
7%
-42%
-31%
53%
62%
35%
36%
28%
39%
47%
37%
50.3
0.28
42.2
15.6
0.17
36.2
16.5
0.54
39% 19%
-49% 63%
163.1
1.05
255.7
1.64
312.5
2.26
31%
-35%
57%
56%
22%
38%
Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.
Our Estimates and Outlook for 2008
For 2008, we forecast net revenue of US$248.9M, up 53% Y/Y, and GAAP-diluted
EPS of US$1.26, up 35% Y/Y, or adjusted EPS (ex-share-based expense) of
US$1.60, up 36% Y/Y. We forecast WoW revenue of US$197.2M (79% of total
revenues), up 31% Y/Y, while we expect revenue contribution to begin from several
other games (GE, Guild Wars, Hellgate: London, etc.), which should help to
diversify The9’s revenue streams (even if they do not become huge hits).
In respect of margins, we forecast gross margin at 45.8% for 2008, up slightly from
44.4% for 2007; adjusted operating margin (ex-share-based expense) of 22.1% for
2008, up slightly from 20.5% for 2007, and adjusted net margin (ex-share-based
expense) of 19.0% for 2008, down slightly from 19.9% for 2007 (due to increase in
effective tax rate in 2008).
Our Estimates and Outlook for 2009
For 2009, we forecast net revenue at US$318.8M, up 28% Y/Y, and GAAP-diluted
EPS of US$1.84, up 47% Y/Y, or adjusted EPS (ex-share-based expense) of
US$2.18, up 37% Y/Y. We forecast gross margin at 48.6% for 2009 (Y/Y
expansion); adjusted operating margin (ex-share-based expense) of 24.2% (Y/Y
expansion) and adjusted net margin of 20.5% (slight Y/Y expansion).
Rating and Price Target
We retain our Overweight rating on the stock, as The9 has one of the most
diversified pipelines, and we believe the risk is on the upside for the company to
operate these games well, despite muted success in the recent two launches. In
addition, the company is trading at a relatively lower valuation compared with other
online game companies.
Our Dec-08 price target is US$34, implying 27.0x 2008E, or 18.4x2009E GAAP
EPS, and 21.3x 2008E, or 15.6x2009E adjusted EPS. The price target is also in line
with our DCF valuation. We believe the company will trade at the low end of its
historical trading range due to uncertainty in WoW license renewal and increasing
costs.
Risks to Our Rating and Price Target
Risks to our rating and price target include: (1) lower-than-expected WoW revenue
growth, (2) if The9 is unable to obtain 2nd-term WoW license or is required to pay a
300
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
significant fee, (3) loose control on marketing spending, and (4) lower-than-expected
acceptance in upcoming titles. Positive risks to our target price are additional license
games to The9’s pipeline.
301
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 202: The9—Income statement
US$ in millions, except per share data, year-end December
Revenue
Online games services
Game operation support
SMS services
Other revenue
COGS
Gross Profit
Operating Expenses
Sales & Mktg. expenses
G&A expenses
R&D expenses
Other expenses
Share-based compensation (123R)
EBIT
Adj. EBIT (ex-123R expense)
EBITDA
Equity earnings in affiliates
Net Other Income
Pre Tax Profit
Tax Expense/(Credit)
Net Profit
Adj. Net Profit (ex-123R exp.)
Pre Tax EPS (US$)
After Tax EPS (US$)
Diluted EPS (US$)
Adj. Diluted EPS (US$, ex-123R)
Margins (%)
Gross Margin
Operating Margin (ex-123R exp.)
EBITDA Margin
Net Margin
Adj. Net Margin (ex-123R exp.)
Sequential Growth (%)
Revenue
Gross Profit
Adj. EBIT
Pre Tax Profit
Net Profit
Diluted EPS
Adj. Diluted EPS (ex-123R exp.)
1Q06
26.5
26.1
0.1
0.0
0.2
-14.6
11.9
-4.8
-1.4
-2.3
-1.1
0.0
-0.6
7.1
7.7
12.8
0.1
0.1
7.3
0.0
7.3
7.9
0.29
0.29
0.30
0.33
2Q06
32.2
32.0
0.1
0.0
0.1
-16.7
15.5
-6.8
-2.4
-3.3
-1.1
0.0
-0.6
8.8
9.4
14.5
0.0
1.7
10.5
-0.1
10.5
11.1
0.41
0.42
0.43
0.45
3Q06
29.5
29.0
0.3
0.0
0.2
-15.9
13.6
-5.6
-1.5
-3.2
-1.0
0.0
-0.6
8.0
8.6
13.9
-0.2
0.2
8.0
-0.1
8.1
8.7
0.33
0.33
0.33
0.35
4Q06
36.2
36.1
0.1
0.0
0.1
-19.0
17.3
-7.0
-2.3
-4.0
-0.7
0.0
-0.8
10.3
11.1
16.5
-0.1
2.8
12.9
-0.1
13.5
14.3
0.53
0.55
0.54
0.58
1Q07
35.0
34.5
0.3
0.0
0.1
-18.1
16.9
-7.5
-2.1
-4.2
-1.2
0.0
-0.8
9.3
10.1
15.8
-0.2
0.5
9.6
1.0
8.6
9.4
0.39
0.35
0.34
0.37
2Q07
35.5
34.5
0.9
0.0
0.1
-20.4
15.1
-9.8
-3.0
-5.3
-1.5
0.0
-1.2
5.3
6.5
14.0
-0.3
1.8
6.8
0.1
6.6
7.9
0.26
0.25
0.25
0.29
3Q07
42.2
41.5
0.3
0.0
1.2
-24.5
17.6
-11.8
-4.3
-6.5
-1.1
0.0
-2.3
5.8
8.1
15.6
-0.1
0.3
6.0
0.9
5.1
7.4
0.20
0.17
0.17
0.25
4Q07E
50.9
50.7
0.0
0.0
0.1
-27.8
23.0
-16.8
-6.4
-8.6
-1.8
0.0
-2.5
6.2
8.7
16.4
-0.1
0.4
6.5
1.1
5.4
7.9
0.22
0.18
0.18
0.27
1Q08E
53.2
53.1
0.0
0.0
0.1
-30.0
23.2
-14.9
-5.3
-8.0
-1.6
0.0
-2.5
8.3
10.8
20.3
-0.1
0.3
8.5
1.4
7.0
9.5
0.29
0.24
0.24
0.32
2Q08E
57.3
57.2
0.0
0.0
0.1
-31.9
25.4
-16.0
-5.7
-8.6
-1.7
0.0
-2.5
9.4
11.9
22.0
-0.1
0.2
9.4
1.6
7.8
10.3
0.32
0.27
0.26
0.35
3Q08E
65.8
65.7
0.0
0.0
0.1
-35.4
30.4
-18.1
-6.6
-9.9
-1.6
0.0
-2.5
12.3
14.8
26.9
-0.1
0.1
12.2
2.1
10.2
12.7
0.42
0.35
0.34
0.43
4Q08E
72.7
72.6
0.0
0.0
0.1
-37.6
35.1
-20.0
-7.3
-10.9
-1.8
0.0
-2.5
15.1
17.6
30.8
-0.1
-0.1
14.9
2.5
12.4
14.9
0.51
0.42
0.41
0.50
FY06
124.3
123.2
0.6
0.0
0.6
-66.1
58.2
-24.2
-7.5
-12.8
-3.9
0.0
-2.5
34.1
36.6
57.6
-0.1
4.7
38.7
-0.3
39.4
41.9
1.58
1.61
1.60
1.71
FY07E
163.2
161.2
1.5
0.0
1.5
-90.7
72.5
-45.8
-15.6
-24.6
-5.6
0.0
-6.8
26.7
33.5
61.7
-0.7
2.9
29.0
3.2
25.8
32.5
1.05
0.94
0.93
1.17
FY08E
248.9
248.5
0.1
0.0
0.3
-134.8
114.1
-69.0
-24.9
-37.3
-6.8
0.0
-10.0
45.1
55.1
100.0
-0.5
0.4
45.1
7.7
37.4
47.4
1.53
1.27
1.26
1.60
FY09E
318.8
318.4
0.0
0.0
0.4
-163.9
154.9
-87.7
-31.9
-47.8
-8.0
0.0
-10.0
67.2
77.2
139.1
-0.5
-0.1
66.7
11.3
55.3
65.3
2.26
1.88
1.84
2.18
44.8
28.9
48.2
27.7
29.9
48.2
29.0
45.0
32.7
34.6
46.2
29.1
47.0
27.6
29.5
47.7
30.5
45.6
37.2
39.4
48.2
29.0
45.1
24.5
26.8
42.4
18.3
39.3
18.7
22.2
41.8
19.3
37.0
12.1
17.5
45.2
17.2
32.2
10.6
15.5
43.7
20.4
38.2
13.2
17.9
44.4
20.7
38.3
13.7
18.1
46.2
22.5
40.9
15.4
19.2
48.2
24.2
42.4
17.0
20.4
46.8
29.4
46.3
31.7
33.7
44.4
20.5
37.8
15.8
19.9
45.8
22.1
40.2
15.0
19.0
48.6
24.2
43.6
17.4
20.5
0.0
-2.2
16.6
-3.7
-13.9
-14.2
-7.6
21.4
30.5
21.8
42.6
43.3
41.3
38.7
-9.4
-13.1
-9.3
-24.0
-23.7
-23.6
-22.6
22.7
26.5
28.9
61.1
65.4
64.8
63.1
-3.5
-2.3
-8.3
-25.8
-36.4
-37.1
-35.1
1.5
-10.7
-36.1
-29.2
-22.3
-27.2
-21.4
18.9
17.2
25.5
-11.6
-23.3
-31.0
-15.3
20.6
30.4
7.3
8.0
5.6
5.9
6.9
4.6
0.9
24.1
30.8
30.8
30.5
20.8
7.7
9.5
9.7
11.3
11.3
11.1
8.1
14.9
19.6
24.7
29.7
29.7
29.4
22.2
10.5
15.3
18.7
21.6
21.6
21.3
17.0
118.8
112.2
401.6
349.3
345.0
339.2
367.4
31.3
24.5
-8.5
-25.2
-34.6
-42.0
-31.2
52.5
57.4
64.5
55.6
45.2
35.4
35.9
28.1
35.8
40.2
47.9
47.9
46.5
36.5
Source: Company and JPMorgan estimates. Note: We have included 123R share-based compensation adjustments starting 2006.
302
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 203: The9 Annual Balance Sheet
US$ in millions, year-end December
Cash and Cash Equivalents
Account Receivables
Inventory
Total Other Current Assets
Total Current Assets
Gross Fixed Assets
Accumulated Depreciation
Net Fixed Assets
Other Long Term Assets
Long Term Investments and Associates
Total Long Term Assets
Total Assets
FY06
118.3
1.3
14.1
3.5
137.1
44.8
(16.2)
28.7
34.6
4.5
67.8
204.9
FY07E
263.2
3.9
11.0
13.3
291.4
94.8
(33.8)
61.0
40.9
19.7
121.5
412.9
FY08E
293.0
5.6
15.9
13.4
327.9
146.0
(62.4)
83.6
51.0
19.4
154.0
482.0
FY09E
357.9
6.3
18.0
13.4
395.6
206.0
(105.7)
100.3
40.6
19.0
159.8
555.4
ST Debt and Current Portion of LT Debt
Accounts Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Long Term Liabilities
Total Long Term Liabilities
Share Capital
Share Premium
Other Reserves
Retained Earnings
Preferred Stock
Total Equity
4.6
25.1
6.6
36.4
0.3
118.8
2.6
46.9
168.5
27.5
8.0
35.6
0.3
299.5
2.7
74.8
377.3
39.8
11.6
51.5
0.3
314.4
2.8
113.0
430.5
45.0
13.1
58.2
0.3
325.8
2.8
168.4
497.3
Total Liabilities and Equity
204.9
412.9
482.0
555.4
FY06
39.4
FY07E
25.8
FY08E
37.4
FY09E
55.3
21.0
(0.4)
2.5
1.6
(6.9)
1.9
7.7
(6.8)
60.1
28.2
6.8
(2.5)
3.7
(9.6)
1.2
1.1
54.7
44.9
10.0
(1.7)
(4.8)
12.0
3.5
101.3
61.9
10.0
(0.7)
(2.1)
5.2
1.5
131.1
Purchase of Property, Plant & Equipment
Purchase/Sale of Other LT assets
Purchase/Sale of Investments
Net Cash from Investing Activities
(9.1)
(5.7)
2.1
(12.8)
(47.5)
(16.3)
(15.0)
(78.8)
(50.1)
(26.4)
0.5
(76.0)
(60.0)
(8.1)
0.5
(67.6)
Issuance/Repayment of Debt
Change in other LT liabilities
Change in Common Equity - net
Payment of Cash Dividends
Other Financing Charges, Net
Net Cash from Financing Activities
Net Change in Cash and Cash Equivalents
Cash at End of Period
1.2
10.4
(2.2)
9.3
56.7
118.3
(4.8)
168.5
0.0
163.7
139.5
263.2
1.4
0.0
1.4
26.7
293.0
1.4
0.0
1.4
64.9
357.9
Source: Company reports, JPMorgan estimates.
Table 204: The9 Annual Cash Flow Statement
US$ in millions, year-end December
Net Income
Add Non cash Expenses/(income)
Depreciation and Amortization
Extraordinaries
Other Non-Cash Items
Changes in Working Capital:
(Increase)/Decrease Receivables
(Increase)/Decrease Inventories
(Increase)/Decrease Other Current Assets
Increase/(Decrease) Payables
Increase/(Decrease) Other Current Liabilities
Net Cash from Operations
Source: Company reports, JPMorgan estimates.
303
Imran Khan
(1-212) 622-6693
[email protected]
304
North America Equity Research
02 January 2008
Appendix
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Table 205: M&A Activity in the Internet Space, 2007
Ticker
Date
Target
Acquirer
AMZN
AMZN
CNET
CNET
DRIV
EBAY
EBAY
EBAY
EBAY
EBAY
EBAY
ELNK
EXPE
EXPE
EXPE
EXPE
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
GOOG
IACI
IACI
IACI
IACI
IACI
IACI
IACI
IACI
IACI
IACI
INCX
INSP
INSP
INSP
INWK
INWK
INWK
INWK
INWK
JUPM
JUPM
JUPM
JUPM
JUPM
JUPM
LINTA
LINTA
LINTA
LINTA
LINTA
5/14/2007
5/23/2007
10/25/2007
11/5/2007
9/5/2007
1/10/2007
2/27/2007
5/3/2007
5/30/2007
10/4/2007
12/20/2007
3/7/2007
12/8/2006
2/28/2007
5/23/2007
6/19/2007
10/31/2006
1/4/2007
3/16/2007
4/13/2007
4/17/2007
4/20/2007
5/29/2007
5/31/2007
6/1/2007
6/6/2007
6/20/2007
7/2/2007
7/9/2007
7/19/2007
9/28/2007
10/9/2007
10/26/2007
12/18/2007
12/20/2006
2/27/2007
2/27/2007
3/1/2007
3/19/2007
4/19/2007
5/9/2007
5/17/2007
5/24/2007
7/2/2007
7/19/2007
1/25/2007
9/17/2007
10/15/2007
10/11/2006
3/8/2007
7/9/2007
11/12/2007
11/12/2007
12/28/2006
1/18/2007
1/30/2007
1/30/2007
6/6/2007
7/18/2007
12/22/2006
2/13/2007
5/9/2007
5/11/2007
8/15/2007
www.Dpreview.Com
Brilliance Audio Inc
Webshots
Findarticles.Com
Netgiro Systems Ab
Stubhub
Beijing Union Mobile Pay Ltd
Gittigidiyor.Com
Stumbleupon Inc
Via-Online Gmbh
Tom Online Inc
Wifi Network
Expedia Inc
Smarter Travel Media Llc
Independent Traveler Inc
Expedia Inc
Jotspot Inc
Shenzen Xunlei Netwk Tech
Adscape Media Inc
Doubleclick
Tonic Systems
Video Conf. Software
Greenborder Tech Ltd
Panoramio.Com
Feedburner Inc
Peakstream Inc
Zenter
Grandcentral Communicat.
Postini
Beijing Feixiangren Informat
Zingku
Jaiku Ltd
Web Search Patent
Endoxon
Ilike.Com
Edodo.Com
Netclub
Insider Pages
Echomusic
Rqi Holdings Ltd
Home Shopping Eur. Gmbh
Front Line Mgmt
Emma Enterntainment Hold
Paciolon
Permierguide Inc
Atlas Mobile Inc
Switchboard.Com
Mobile Services Business
About Applied Graphics Inc
Spectrum Printing Systems
Brown Partners
Data Flow Media Sys, LP
Graphic Resource Group
Justtechjobs.Com
Studiocutz.Com
Ispcon Trade Shows
Inbox Trade Shows
Multiple Targets
Mediabistro.Com Inc
News Corp Cl A
Unnamed Target
Liberty Media Interactive A
Backcountry.Com
Borba Llc
Amazon.com Inc
Amazon.com Inc
American Greetings Corp
CNET Neworks
Digital River Inc
eBay
eBay
eBay
eBay
eBay
eBay
Earth Link
Expedia Inc
Expedia Inc
Expedia Inc
Expedia Inc
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
Google
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
Arcandor AG
IAC/ Interactive corp
IAC/ Interactive corp
IAC/ Interactive corp
LOCAL.COM Corp
Twistbox Entertainment Inc
Idearc Inc
Motricity Inc
Innerworkings Inc
Innerworkings Inc
Innerworkings Inc
Innerworkings Inc
Innerworkings Inc
Jupiter Media Corp
Jupiter Media Corp
Jupiter Media Corp
Jupiter Media Corp
Jupiter Media Corp
Jupiter Media Corp
News Corp L A
Liberty Media Interactive A
Liberty Media Interactive A
Liberty Media Interactive A
Liberty Media Interactive A
Seller
Cnet Networks Inc
Looksmart
Netgiro International Ab
City Of Corpus Christi Tx
Shareholders
Shareholders
Multiple Sellers
Marratech Ab
Invenda Corp Reg
Gaylord Entertainment Co
Iac/ Interactive Corp
Infospace Inc
Infospace Inc
Infospace Inc
Mediatone Music Inc
Golden Group Inc
Golden Group Inc
Liberty Media Interactive A
Cbs Corp Class B
Shareholders
Announced
Total
NA
NA
45
20.5
27
310
105
NA
75
NA
NA
NA
660
NA
NA
725
NA
NA
NA
3100
NA
NA
NA
7
NA
NA
NA
NA
625
NA
NA
NA
2
NA
NA
NA
NA
NA
NA
109.12
196.47
NA
NA
NA
2
NA
225
135
NA
3.35
NA
NA
NA
NA
NA
NA
NA
NA
20
550
68.09
484.47
NA
NA
Payment
Type
Undisclosed
Cash
Cash
Cash
Cash
Cash
Cash
Cash
Cash
Cash
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Cash
Undisclosed
Cash
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Cash
Undisclosed
Cash
Undisclosed
Cash
Cash
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Cash
Cash
Cash
Cash
Cash
Cash
Cash
Stock
Cash
Undisclosed
Deal
Status
Complete
Complete
Complete
Pending
Complete
Complete
Pending
Complete
Complete
Complete
Pending
Pending
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Complete
Complete
Complete
Pending
Complete
Pending
Pending
Pending
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Pending
Complete
Complete
Pending
Complete
307
Imran Khan
(1-212) 622-6693
[email protected]
MCHX
MELI
MELI
MNST
MSFT
MSFT
MSFT
MSFT
MSFT
MSFT
OMTR
OMTR
OMTR
OMTR
OSTK
PCLN
RNWK
RNWK
RNWK
SFLY
SOLD
TFSM
TOMO
TOMO
VCLK
VCLK
YHOO
YHOO
YHOO
YHOO
YHOO
YHOO
YHOO
YHOO
8/9/2007
10/1/2001
11/13/2005
1/17/2007
5/18/2007
8/30/2007
10/3/2007
10/7/2007
10/24/2007
11/12/2007
1/18/2007
2/14/2007
9/7/2007
10/25/2007
4/25/2007
11/8/2007
5/16/2007
8/21/2007
9/27/2007
6/27/2007
11/5/2007
5/17/2007
3/12/2007
12/20/2007
12/4/2006
7/16/2007
1/9/2007
4/24/2007
4/30/2007
6/21/2007
9/4/2007
9/12/2007
9/14/2007
9/17/2007
Voicestar
Ibazar Com Br Ltda
Deremate.Com
Arbeidskamerater As
Aquantive
Screentonic
Jellyfish.Com
Newsvine Inc
Facebook Inc
Musicwave
Instadia
Touch Clarity
Offermatica
Visual Sciences Inc
Otravel.Com Inc
Agoda Co
Sony Netservices Gmbh
Viacom Inc Class B
Game Trust Inc
Make It About Me!
Realty Generator
24/7 Real Media Inc
Tom Online Inc
Tom Online Inc
Shopping.Net
Mezimedia Inc
Mybloglog
Overture Kk
Right Media Inc
Rivals.Com
Bluelithium Inc
Speedcast Holdings Ltd
Buzztracker.Com
Zimra Inc
Source: Bloomberg, company reports, news reports.
308
North America Equity Research
02 January 2008
Marchex INC CLASS B
MercadoLibre Inc
MercadoLibre Inc
Monster Worldwide
Microsoft
Microsoft
Microsoft
MULTIPLE ACQUIRERS
Microsoft
Microsoft
Omniture Inc
Omniture Inc
Omniture Inc
Omniture Inc
MULTIPLE ACQUIRERS
Priceline.com Inc
Real Networks Inc
Real Networks Inc
Real Networks Inc
Shutterfly
Housevalues
WPP Group PLC
Tom Group Online
eBay
ValueClick Inc
ValueClick Inc
Yahoo! Inc
YAHOO! JAPAN CORP
Yahoo! Inc
Yahoo! Inc
Yahoo! Inc
Asia Satellite Telecom Hldg
Yahoo! Inc
Yahoo! Inc
21.82
Ebay Inc
NA
NA
NA
5460.65
NA
NA
NA
240
50
14.41
48.5
65
390.27
17
Openwave Systems
Overstock.Com Inc
Sony Corp
NA
NA
NA
NA
NA
NA
580.67
283.94
NA
26.28
100
Yahoo! Inc
NA
340
NA
Multiple Sellers
Participate Media
300
2.96
NA
350
Cash & Stock
Stock
Undisclosed
Undisclosed
Cash
Undisclosed
Undisclosed
Undisclosed
Cash
Cash
Cash
Cash
Cash & Stock
Cash & Stock
Cash
Cash
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Undisclosed
Cash
Cash
Undisclosed
Cash
Cash
Undisclosed
Cash & Stock
Undisclosed
Cash
Cash
Cash
Undisclosed
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Complete
Pending
Pending
Complete
Pending
Pending
Pending
Complete
Complete
Pending
Pending
Pending
Complete
Complete
Complete
Complete
Pending
Complete
Pending
Complete
Pending
Complete
Pending
Complete
Complete
Complete
Pending
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Analyst Certification:
The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily
responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with
respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report
accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research
analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the
research analyst(s) in this report.
Important Disclosures for Asian Companies
•
•
•
•
•
•
•
Market Maker: JPMSI makes a market in the stock of Baidu.com, China Finance Online, Netease, Ninetowns Internet Technology
Group Co. Ltd., Shanda Interactive Entertainment Ltd, Sina Corp, Sohu.Com, The9 Limited.
Market Maker/ Liquidity Provider: JPMSL and/or an affiliate is a market maker and/or liquidity provider in Sina Corp,
Sohu.Com.
Lead or Co-manager: JPMSI or its affiliates acted as lead or co-manager in a public offering of equity and/or debt securities for
Ninetowns Internet Technology Group Co. Ltd. within the past 12 months.
Client of the Firm: China Finance Online is or was in the past 12 months a client of JPMSI. Netease is or was in the past 12 months
a client of JPMSI. Ninetowns Internet Technology Group Co. Ltd. is or was in the past 12 months a client of JPMSI; during the past
12 months, JPMSI provided to the company investment banking services. Shanda Interactive Entertainment Ltd is or was in the past
12 months a client of JPMSI. Sohu.Com is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI
provided to the company non-investment banking securities-related service and non-securities-related services.
Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking
services from Ninetowns Internet Technology Group Co. Ltd..
Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investment
banking services in the next three months from China Finance Online, Ninetowns Internet Technology Group Co. Ltd..
Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other
than investment banking from Sohu.Com. An affiliate of JPMSI has received compensation in the past 12 months for products or
services other than investment banking from China Finance Online, Ninetowns Internet Technology Group Co. Ltd., Shanda
Interactive Entertainment Ltd, Sohu.Com.
Important Disclosures for US Equity Research Compendium Reports: Important disclosures, including price charts for all
companies under coverage for at least one year, are available through the search function on JP Morgan’s website
https://mm.jpmorgan.com/disclosures/company or by calling this U.S. toll-free number (1-800-477-0406).
Explanation of Equity Research Ratings and Analyst(s) Coverage Universe:
JPMorgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the
average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve
months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s)
coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of
the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] The analyst or analyst’s team’s coverage universe is the sector
and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.
Coverage Universe: Imran Khan: Amazon.com (AMZN), Blue Nile (NILE), CNET Networks (CNET), Dice Holdings,
Inc. (DHX), Expedia, Inc. (EXPE), Google (GOOG), HouseValues, Inc (SOLD), InfoSpace Inc (INSP), InnerWorkings
(INWK), InterActiveCorp (IACI), Liberty Interactive (LINTA), Mercadolibre, Inc. (MELI), Monster Worldwide Inc
(MNST), Move (MOVE), News Corporation, Inc. (NWSa), Omniture, Inc. (OMTR), Orbitz Worldwide, Inc. (OWW),
Priceline.com (PCLN), Shutterfly, Inc. (SFLY), The Walt Disney Co. (DIS), Time Warner (TWX), ValueClick (VCLK),
Viacom Inc (VIAb), Xinhua Finance Media (XFML), Yahoo Inc (YHOO), eBay, Inc (EBAY)
Dick Wei: Baidu.com (BIDU), China Finance Online (JRJC), Netease (NTES), Ninetowns Internet Technology Group Co.
Ltd. (NINE), Shanda Interactive Entertainment Ltd (SNDA), Sina Corp (SINA), Sohu.Com (SOHU), The9 Limited (NCTY)
309
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
JPMorgan Equity Research Ratings Distribution, as of September 28, 2007
JPM Global Equity Research Coverage
IB clients*
JPMSI Equity Research Coverage
IB clients*
Overweight
(buy)
46%
51%
42%
70%
Neutral
(hold)
40%
50%
46%
63%
Underweight
(sell)
14%
38%
12%
49%
*Percentage of investment banking clients in each rating category.
For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold
rating category; and our Underweight rating falls into a sell rating category.
Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on
any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on
the front of this note or your JPMorgan representative.
Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon
various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which
include revenues from, among other business units, Institutional Equities and Investment Banking.
Other Disclosures
Options related research: If the information contained herein regards options related research, such information is available only to persons who
have received the proper option risk disclosure documents. For a copy of the Option Clearing Corporation’s Characteristics and Risks of
Standardized Options, please contact your JPMorgan Representative or visit the OCC’s website at
http://www.optionsclearing.com/publications/risks/riskstoc.pdf.
Legal Entities Disclosures
U.S.: JPMSI is a member of NYSE, FINRA and SIPC. J.P. Morgan Futures Inc. is a member of the NFA. JPMorgan Chase Bank, N.A. is a
member of FDIC and is authorized and regulated in the UK by the Financial Services Authority. U.K.: J.P. Morgan Securities Ltd. (JPMSL) is a
member of the London Stock Exchange and is authorised and regulated by the Financial Services Authority. Registered in England & Wales No.
2711006. Registered Office 125 London Wall, London EC2Y 5AJ. South Africa: J.P. Morgan Equities Limited is a member of the Johannesburg
Securities Exchange and is regulated by the FSB. Hong Kong: J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated
by the Hong Kong Monetary Authority and the Securities and Futures Commission in Hong Kong. Korea: J.P. Morgan Securities (Far East) Ltd,
Seoul branch, is regulated by the Korea Financial Supervisory Service. Australia: J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS
Licence No: 238188) is regulated by ASIC and J.P. Morgan Securities Australia Limited (ABN 61 003 245 234/AFS Licence No: 238066) is a
Market Participant with the ASX and regulated by ASIC. Taiwan: J.P.Morgan Securities (Taiwan) Limited is a participant of the Taiwan Stock
Exchange (company-type) and regulated by the Taiwan Securities and Futures Bureau. India: J.P. Morgan India Private Limited is a member of
the National Stock Exchange of India Limited and The Stock Exchange, Mumbai and is regulated by the Securities and Exchange Board of India.
Thailand: JPMorgan Securities (Thailand) Limited is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance
and the Securities and Exchange Commission. Indonesia: PT J.P. Morgan Securities Indonesia is a member of the Jakarta Stock Exchange and
Surabaya Stock Exchange and is regulated by the BAPEPAM. Philippines: J.P. Morgan Securities Philippines Inc. is a member of the Philippine
Stock Exchange and is regulated by the Securities and Exchange Commission. Brazil: Banco J.P. Morgan S.A. is regulated by the Comissao de
Valores Mobiliarios (CVM) and by the Central Bank of Brazil. Mexico: J.P. Morgan Casa de Bolsa, S.A. de C.V., J.P. Morgan Grupo Financiero
is a member of the Mexican Stock Exchange and authorized to act as a broker dealer by the National Banking and Securities Exchange
Commission. Singapore: This material is issued and distributed in Singapore by J.P. Morgan Securities Singapore Private Limited (JPMSS)
[mica (p) 030/09/2007 and Co. Reg. No.: 199405335R] which is a member of the Singapore Exchange Securities Trading Limited and is
regulated by the Monetary Authority of Singapore (MAS) and/or JPMorgan Chase Bank, N.A., Singapore branch (JPMCB Singapore) which is
regulated by the MAS. Malaysia: This material is issued and distributed in Malaysia by JPMorgan Securities (Malaysia) Sdn Bhd (18146-x)
which is a Participating Organization of Bursa Malaysia Securities Bhd and is licensed as a dealer by the Securities Commission in Malaysia.
Pakistan: J. P. Morgan Pakistan Broking (Pvt.) Ltd is a member of the Karachi Stock Exchange and regulated by the Securities and Exchange
Commission of Pakistan.
Country and Region Specific Disclosures
U.K. and European Economic Area (EEA): Issued and approved for distribution in the U.K. and the EEA by JPMSL. Investment research
issued by JPMSL has been prepared in accordance with JPMSL’s Policies for Managing Conflicts of Interest in Connection with Investment
Research which outline the effective organisational and administrative arrangements set up within JPMSL for the prevention and avoidance of
conflicts of interest with respect to research recommendations, including information barriers, and can be found at
http://www.jpmorgan.com/pdfdoc/research/ConflictManagementPolicy.pdf. This report has been issued in the U.K. only to persons of a kind
described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (all such persons
being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment
or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In
other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction Germany:
310
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
This material is distributed in Germany by J.P. Morgan Securities Ltd. Frankfurt Branch and JPMorgan Chase Bank, N.A., Frankfurt Branch who
are regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht. Australia: This material is issued and distributed by JPMSAL in Australia
to “wholesale clients” only. JPMSAL does not issue or distribute this material to “retail clients.” The recipient of this material must not distribute
it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms “wholesale
client” and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Hong Kong: The 1% ownership
disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for persons
licensed by or registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the
disclosure may be based on the month end data from two months’ prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider for
derivative warrants issued by J.P. Morgan International Derivatives Ltd and listed on The Stock Exchange of Hong Kong Limited. An updated list
can be found on HKEx website: http://www.hkex.com.hk/prod/dw/Lp.htm. Japan: There is a risk that a loss may occur due to a change in the
price of the shares in the case of share trading, and that a loss may occur due to the exchange rate in the case of foreign share trading. In the case
of share trading, JPMorgan Securities Japan Co., Ltd., will be receiving a brokerage fee and consumption tax (shouhizei) calculated by
multiplying the executed price by the commission rate which was individually agreed between JPMorgan Securities Japan Co., Ltd., and the
customer in advance. Financial Instruments Firms: JPMorgan Securities Japan Co., Ltd., Kanto Local Finance Bureau (kinsho) No. [82]
Participating Association / Japan Securities Dealers Association, The Financial Futures Association of Japan. Korea: This report may have been
edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul branch. Singapore: JPMSI and/or its
affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding
is disclosed in the Legal Disclosures section above. India: For private circulation only not for sale. Pakistan: For private circulation only not
for sale. New Zealand: This material is issued and distributed by JPMSAL in New Zealand only to persons whose principal business is the
investment of money or who, in the course of and for the purposes of their business, habitually invest money. JPMSAL does not issue or distribute
this material to members of "the public" as determined in accordance with section 3 of the Securities Act 1978. The recipient of this material must
not distribute it to any third party or outside New Zealand without the prior written consent of JPMSAL.
General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan
Chase & Co. or its affiliates and/or subsidiaries (collectively JPMorgan) do not warrant its completeness or accuracy except with respect to any
disclosures relative to JPMSI and/or its affiliates and the analyst’s involvement with the issuer that is the subject of the research. All pricing is as
of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this
material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or
solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual
client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to
particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments
mentioned herein. JPMSI distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic
updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other
publicly available information. Clients should contact analysts and execute transactions through a JPMorgan subsidiary or affiliate in their home
jurisdiction unless governing law permits otherwise.
“Other Disclosures” last revised December 10, 2007.
Copyright 2007 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or
redistributed without the written consent of JPMorgan.
311
Imran Khan
(1-212) 622-6693
[email protected]
North America Equity Research
02 January 2008
Imran Khan and the JPMorgan Internet, Media and Entertainment team
Imran Khan
Imran Khan is a Managing Director and the Senior Internet, Media and Entertainment Analyst at JPMorgan. Mr. Khan
ranked #2 for Internet in the Institutional Investor All America Research Poll in 2005, 2006, and 2007. Additionally, he has
been consistently recognized as one of the top Internet analysts in the Greenwich Research Poll since 2005. Mr. Khan has
authored several widely read research reports, including past editions of the Nothing But Net report, as well as “The Rise of
Ad Networks” and “Large Cap Courtship and Consolidation”. Mr. Khan is a sought-after speaker and has presented at
leading industry conferences such as Ad-Tech, Red Herring, AlwaysOn, and Young & Rubicam Digital Day. Mr. Khan has
also received invitations as a guest speaker at multiple universities.
Mr. Khan came to JPMorgan in 2004 after three years at Fulcrum Global Partners, where he was a Managing Director in
Equity Research covering Internet and Software. Prior to Fulcrum, Mr. Khan worked as an investment banker at ING,
covering Telecom. Before ING, he worked for Wild Blue, a satellite start-up company.
Bridget Weishaar
Bridget Weishaar joined the JPMorgan Internet, Media and Entertainment team in 2006. Prior to JPMorgan, Ms. Weishaar
was a member of the Retail team at Bear Stearns, which ranked #1 in the Institutional Investor All America Research Poll in
2005. Ms. Weishaar obtained her MBA at the Wharton School, University of Pennsylvania, and holds a B.S. from the
University of Notre Dame.
Joseph Boushelle
Joe Boushelle joined the JPMorgan Internet, Media and Entertainment team in 2007. Previously, Mr. Boushelle covered the
oil and gas sector for a credit trading group. Mr. Boushelle is a CFA charterholder, and received an M.B.A. with distinction
from Cornell University and a B.A. in Economics from the University of Chicago.
Lev Polinsky
Lev Polinsky joined the JPMorgan Internet, Media and Entertainment team in 2006. Prior to JPMorgan, Mr. Polinsky was a
trader at Susquehanna Investment Group, covering a variety of industries. Mr. Polinsky is a CFA charterholder, and
received an A.B. in Economics from Harvard University.
Vasily Karasyov
Vasily Karasyov joined the JPMorgan Internet, Media and Entertainment team in 2006, focusing on Media and
Entertainment companies. Prior to JPMorgan, he was an Executive Director, Corporate Development at Sony Pictures,
where he worked on M&A and financing transactions, as well as strategic planning in film, television, home entertainment
and new media. Mr. Karasyov holds an MBA from INSEAD.
Dick Wei
Dick Wei’s primary research focus is on China Internet. In addition, he is also responsible for global technology research.
Prior to joining JPMorgan in 2002, Mr. Wei worked with Merrill Lynch in the Hong Kong and New York offices. He was
also a design engineer at Quantum Corporation (acquired by Maxtor). Mr. Wei graduated with an MBA from the Wharton
School and obtained his M.Sc. degree in mechanical engineering from Stanford University.

Similar documents