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An Update from the Digital World – Pace of Global Technology Innovation Is Accelerating (12 Pages)
December 23, 2005
Global Internet
An Update from the Digital
World – Pace of Global
Technology Innovation Is
Accelerating – December
2005
•Broadband and mobile drive new computing
cycles. Global technology innovation is accelerating
and is becoming a major driving force in the next two
major, and converging, computing cycles for the
evolution of the Internet — one for broadband Internet
usage and the other for mobile Internet usage.
Consumers around the world, not enterprises, are
driving demand. For businesses, the opportunities —
and potential dislocations — are significant. For China,
the opportunities to help set the pace for the
development of the Internet (especially in mobile) are
very real.
Desire to communicate is at core of innovation.
Communication accounts for 45%, and rising, of
online usage in the United States. Internet leader
are vying to become next-generation global
communication hubs. Mobile network speeds continue
to advance, greasing the skids for innovation on the
mobile platform. Revenue models for broadband and
mobile Internet are now different but will likely
converge.
Asian companies no longer just ‘fast followers’. A
rising number of Asian companies have begun to ramp
up innovation with a focus on anticipating customer and
consumer needs. We see a core group of nextgeneration
customers in China, where there are more
Internet and mobile phone users under the age of 30
than in any market in the world.
A version of this report appeared in the Chinese
business weekly Caijing on December 10, 2005.
Morgan Stanley 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 Morgan Stanley
in the U.S. can receive independent, third-party
research on the company covered in this report, at
no cost to them, where such research is available.
Customers can access this independent research at
www.morganstanley.com/equityresearch or can call
1-800-624-2063 to request a copy of this research.
Please see analyst certification and other
important disclosures starting on page 8.
+= Analysts employed by non-U.S. affiliates are not registered pursuant to NASD/NYSE rules.
Morgan Stanley & Co. Incorporated Mary Meeker
Mary.Meeker@morganstanley.com
+1 (1)212 761 8042
Brian Pitz
Brian.Pitz@morganstanley.com
+1 (1)212 761 4133
Brian Fitzgerald
Brian.Fitzgerald@morganstanley.com
+1 (1)212 761 4276
Morgan Stanley Dean Witter Asia
Limited+
Richard Ji
Richard.Ji@morganstanley.com
+852 2848 6926
M O R G A N S T A N L E Y E Q U I T Y R E S E A R C H
N O R T H A M E R I C A
Industry View
Attractive
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An Update from the Digital World – Pace of Global Technology
Innovation Is Accelerating – December 2005
Global technology innovation is accelerating and is becoming a major driving force in the next two major, and
converging, computing cycles for the evolution of the Internet — one for broadband Internet usage and the other
for mobile Internet usage. The first ten years (1995-2005) of the commercial Internet look to us like a warm-up act for
what is about to happen. For the next ten years, a lot of the innovation will likely will come from outside the United
States. Core Internet innovation remains robust in the United States (note the successes of companies like Google,
Yahoo!, eBay and Amazon.com). But Northern / Eastern Europe (with Linux and Skype), India (with outsourcing) and
China and Asia (with mobile phone advancements) are showing unprecedented strength in innovation.
Consumers around the world, not enterprises, are driving demand. For businesses, the opportunities — and
potential dislocations — are significant. For China, the opportunities to help set the pace for the on-going
development of the Internet (especially in mobile) are very real. Just as Asian consumers have adopted many of the
types of broadband services developed in the United States, so we believe, increasingly, consumers in the United
States will adopt mobile services developed in Asia.
Just a few years ago, few could have predicted that Internet technology would be adopted so quickly and so
broadly around the globe:
1. 1 billion Internet users, with fewer than 25% in North America and China as the No. 2 market behind the US.
2. 2 billion mobile phone users, with fewer than 15% in North America and China as the No. 1 market.
3. South Korea leads world in broadband penetration, at 70% of households.
4. China leads world in number of Internet users under the age of 30, at 70 million.
5. 180 million consumers subscribe to broadband Internet access, with 45% growth in mid-2005.
6. Skype has 61 million registered users of its free voice-over-Internet-Protocol (VoIP) telecom service, with 340
percent growth in late 2005.
7. Owing to rapid acceptance of VoIP, ‘free’ voice communication exceeds landline communication usage in
Denmark.
8. Tencent supports 16 million simultaneous Instant Messaging (IM) users in China, with 75 percent growth.
9. Google served up 8 billion searches in mid-2005, with 75% growth.
10. eBay’s PayPal online payment system has 90 million registered users, with 50% growth.
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Exhibit 1
Global Internet & Mobile Phone Users by Region
Asia Pacific
41%
Europe
19%
ROW
18%
N. America
11% South
America
11%
Mobile Subscribers – 2B
C2005E (2)
Asia
Pacific
36%
Europe
24% ROW
12%
N. America
23% South
America
5%
Internet Users – 1B
C2005E (1)
(1) Source: Morgan Stanley Research. (2) Source: Morgan Stanley Communications Equipment Research: Scott Coleman, John Marchetti.
We have entered two of the most important computing cycles of the last fifty years, defined by broadband and
mobile Internet technologies. Every few decades over the past half-century, we have undergone a major computing
cycle (including the cycles for mainframe computing, mini-computing, and personal computing). Today, we are in the
early stages of two computing cycles, for broadband Internet and for mobile Internet usage. Broadband has already
entered the ‘sweet spot’ of its adoption cycle, at a level of penetration representing 25% of global users in 2004; 2.5G
mobile services (which allow for basic Internet connectivity) should enter their own ‘sweet spot’ of adoption within two
years.
Consumers, not enterprises, are driving demand. This is evident to us in Microsoft’s third-quarter financial results:
the company indicated consumer demand for lower-price PCs drove 15-17% PC unit growth, but only 7% revenue
growth for the Windows operating system business.
Public market financings, for non-United States based companies, as a percentage of total technology
financings, are at an all time high, and rising. In 2005 year-to-date, as of 11/11/05, non-US technology company
financings accounted for 65% of technology financings, versus 58% in 2004, 51% in 2003 and 39% in 1998. Non-
Japan Asia has supported the highest and most consistent growth and, 2005 year-to-date, accounted for 37% of total
public technology financings in dollar terms. These trends are evidence that global investors have been willing to
commit rising amounts of capital to Asian technology companies. The onus is on the Asian companies to prove that
they are built for the long-term.
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The desire to communicate and connect, combined with the acceptance and convergence of usage of
broadband and mobile Internet is at the core of the innovation. Communication accounts for 45%, and rising, of
online usage in the United States. For many users, instant messaging has already surpassed e-mail as a primary way
of communicating online; VoIP, blogging, and user-generated content are quickly gaining momentum.
Internet leaders like Google, Yahoo!, eBay and Microsoft are not the only ones vying to become global nextgeneration
communications hubs. They aim to leverage their relative strengths in online search, community,
content, messaging, commerce and payments to be the ‘go-to’ places for consumers to connect. It is worth noting,
however, that these companies are not the only ones that support tens of millions — and often, hundreds of millions of
users — of their core products. The leading mobile service providers — China Mobile (with 225 million subscribers);
Vodafone (165 million); China Unicom (120 million) and China Netcom (120 million) — also desire to be nextgeneration
market leaders. They have hefty user bases and active development environments for mobile value added
services (MVAS) to support their efforts.
Mobile network speeds continue to advance, greasing the skids for innovation on the mobile platform. 2.5G
should enter a ‘sweet spot’ of sorts over the next two years, as 25% of users use the service. 2.5G allows for basic
downloads, like ringtones and screensavers, and limited Web browsing. However, we believe the adoption of 3G, with
speeds of 200-700 Kbps, will be key to monitor for more advanced development of the mobile Internet. In addition, it
will be important to observe the rollout of WiFi / WiMax services, and their potential roles as mobile networks. As we
saw with the conversion of the dial-up Internet to the broadband Internet, faster access speeds make for more
compelling user experiences, and create a more feasible environment for developing applications and services.
Increasingly, as mobile phone features and access speeds improve, users will expect, in effect, to use their phones as
remote control devices to search and pay for products, services and information.
Exhibit 2
Broadband vs. Mobile Internet Revenue Composition
Commerce
61%
Advertising
36%
Payments
3%
Top 10 Internet Companies - Revenue Composition
CQ2 Annualized - $28B
Revenue Composition - Mobile Internet
C2005E - $19B
Enterprise
Services
10%
Search / 411
16% Other Info &
Infotainment
24%
Games
10%
Music &
Video
4%
Gambling
1%
Personalization (1)
35%
Source: Left Chart - Morgan Stanley Research estimates: includes revenue from Google, eBay, Yahoo!, Yahoo! Japan, Amazon.com, T-Online, InterActive, Time Warner (AOL only, ex-access),
Microsoft (MSN only, ex-access), and Rakuten. Right Chart – Morgan Stanley Research estimates, Global Data. Informa (5/05), Ovum (5/05). (1) Personalization includes ringtones, wallpapers,
and screensavers. If SMS / MMS were added to Mobile Internet—it would add $55B to total revenue and would account for 74% of total revenue.
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Revenue models for broadband and mobile Internet are now different but will likely grow to resemble each
other. Most of the billions of dollars in annual non-access broadband Internet revenue is generated through
commerce and advertising; mobile Internet revenue is generated by content and services including ringtones,
wallpaper, screensavers, music, entertainment and music. In effect, broadband revenue is generated when vendors
pay for advertising to consumers on web sites like Google or Yahoo! or when vendors or consumers pay commissions
for products on sites like eBay or Amazon.com. Mobile revenue is generated, for the most part, when consumers pay
mobile providers for specific content and services.
The success of Apple iTunes for iPod (with 7 million players and 565 million tunes sold) suggests that consumers will
pay for online music one song at a time (for $0.99). We believe the next exciting market will be for online video. Some
estimates indicate that 40% of Internet traffic is used for peer-to-peer (P2P) file sharing of video, implying that video
providers are missing a large potential market opportunity by not fostering an environment where online video is easyto-
search and easy-to-buy. We think this is in the early stages of changing — we are encouraged by the recent rapid
market acceptance of Disney / ABC’s video sales for the Apple iPod.
Owing to efforts of leading Internet companies, online users have become accustomed to finding what they are
searching for and, in our view, users have grown weary of not being able to find video content they are searching for.
We believe market forces are about to change -- while mobile users have been actively willing to pay for a-la-carte
content like ringtones, we believe broadband users will increasingly prove they will do the same. Simply, increasingly,
users will be able to find what they are looking for anytime, anywhere.
Conversely, while advertising and commission-based revenue is underdeveloped in the mobile market, we believe that
improving access speeds and rising acceptance of payment systems and enhanced search-related features for mobile
phones will help drive these revenue streams. The rapid ramp of Google’s revenue and profit growth is proof that
vendors find Google’s on-demand online customer acquisition tools to be quite effective — and Google is just
beginning to tap this opportunity in the mobile market.
Historically, many Asian technology companies have been criticized for being ‘fast followers’ rather than fast
innovators. We believe this trend has begun to change, and a rising number of companies have begun to ramp up
focus on anticipating customer and consumer needs. We cite Japan’s NTT DoCoMo (mobile data services), KDDI
(mobile data services), Toshiba (flash memory), Sharp (TFT LCDs and solar cells) and Canon (imaging); Korea’s
Samsung (memory) and SK Telecom (mobile data services); Taiwan’s TSMC (flexible semiconductor manufacturing);
India’s iFlex (banking application software) and Infosys (outsourcing), Tencent (instant messaging), NetEase (online
gaming), Ctrip (online and offline travel) and Tom Online (mobile value added services) as good examples.
We see a core group of next-generation customers in China, where there are more Internet and mobile phone
users under the age of 30 than in any market in the world. Combined with the highest outpouring of engineering
graduates in the world plus financial incentives and rising levels of courage, this may help drive a surprising amount of
innovation. Already, Asia leads the world in mobile-based services such as gaming and video-blogging and mobile
phones -- in addition to becoming fashion statements, mobile phones have become ‘must own’ products.
History has proven that when a country combines government commitment, strong leadership, national pride,
academic focus on engineering and innovation with consumer interest in the usage of technology products,
ecosystems develop that can lead to impressive technology innovation. While ‘Rome was not built in a day,’ we are
optimistic about the five-to-ten year outlook for technology innovation in Asia, and in China in particular. The
opportunity exists, now it is a question of execution…
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Updates from the Digital World – An Overview
Since our first “Digital World” report, published in 2002, we have used this series to discuss some major events and inflection points
related to the Internet that we thought were underappreciated. Below, you will find a list of our “Digital World” reports to date. In
this report, we update our Internet Ecosystem Framework and review current trends for key Internet usage and user metrics.
• Update to our Internet Ecosystem Framework
December 2005: We compile what we believe are the most relevant publicly available metrics that represent key market trends in
various parts of the Internet usage/user spectrum.
• Syndication, Blogs and RSS
October 2004: Getting news/information when you want it is getting easier and easier. We focus on three factors that are
combining to help drive online momentum: 1) rising usage of RSS (Really Simple Syndication) by content providers as a standard
distribution platform for online content; 2) ramp in creation of blogs and other user-generated content and 3) Yahoo!’s easy-to-use
integration of RSS feeds with My Yahoo!. Google may have set the pace for searching information, but Yahoo! may be setting the
pace for new ways of serving information…“next-generation content” should gain usage / revenue traction in C2005E.
• Update to our Internet Ecosystem Framework
February 2004: We compile what we believe are the most relevant publicly available metrics that represent key market trends in
various parts of the Internet usage/user spectrum.
• Who Has the Momentum?
November 2003: To determine which Web sites are supporting the greatest growth momentum, we reviewed multi-factor rankings
aggregating absolute and sequential trends for visitors, page views, and usage minutes at 1,217 leading properties/sites (using US
Media Metrix data). Growth trends for advertising, commerce, content, and community continue to look encouraging.
• Microsoft, it’s the Sound of Online Music?
June 2003: In our view, the day (May 29, 2003) that Microsoft agreed to pay AOL Time Warner $750MM to settle the lawsuit
related to Microsoft’s Netscape-targeted business practices marked an end, and a beginning, for the evolution of the Internet. To
put this event in a historical context in our report, we told a short story of the evolution of the commercial Internet to date. Recent
data related to online music — a natural SFO business — gave us the sense that music could, finally, become a catalyst that
changes the rules of the game in the evolution of the Internet. We also focused on Microsoft’s front- and back-end Internet-related
initiatives with forthcoming releases of Internet Explorer, MSN, and Windows (Longhorn), and ongoing developments to the
company’s Web services (.NET) efforts.
• What’s New at Yahoo!?
April 2003: We focused on the positive core secular trends in Internet advertising and drilled down on Yahoo! as a proxy and driver
of these trends. In addition, we touched on what we saw as an impressive list of improvements by Yahoo! to provide a better
experience for users and more effective marketing for advertisers.
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Updates from the Digital World – An Overview (continued)
• Who’s Keeping the Customer Satisfied — and How?
Late-March 2003: Internet leaders such as Amazon.com, eBay, and Expedia had just scored strong relative results in customer
satisfaction in the highly regarded American Customer Satisfaction Survey. Convenience, low (and transparent) prices/pricing,
uniquely strong 24x7 customer service, and extensive selection had long been key factors behind the growth for leading online
commerce (and information) sites. These attributes were becoming increasingly apparent to us (and measurable). Owing in part to
the power of their technology platforms, Internet leaders were raising the bar on customer satisfaction and loyalty.
• What Brought on the Strong Momentum of CQ4:02?
March 2003: In addition to improvements in the SFO experiences of the Internet, a key part of the answer may have been the scale
and ramp of residential broadband usage, which made possible the emergence of what we saw as a group of Internet-enabled
“power consumers.”
• The Great Online Migration — Is eBay a Replay of New York City’s 18th Century?
February 2003: We focused on the relevance and magnitude of sellers and buyers migrating online, as illustrated by eBay’s
momentum, and we drew some historical analogies to the dynamics of the settlement and growth of New York City.
• Is Search/Find/Obtain (SFO) Becoming the Internet’s Third Killer Application?
December 2002: Our first “Digital World” report examined online vs. offline momentum related to expanded global distribution,
lower relative pricing related to transparency and the ramp in the sale of used goods, and the rising impact of replacement
products.
All of Morgan Stanley’s equity research technology reports are available on the Internet through Client Link on
www.morganstanley.com. If you wish to receive this service, please contact your institutional sales representative. All of the above
reports (along with other technology overview reports) also can be downloaded from www.morganstanley.com/techresearch. For
our thoughts on companies mentioned in these reports, see our company-specific reports
.
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The information and opinions in this report were prepared by Morgan Stanley & Co. Incorporated and its affiliates (collectively,
"Morgan Stanley").
Analyst Certification
The following analysts hereby certify that their views about the companies and their securities discussed in this report are
accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for
expressing specific recommendations or views in this report: Brian Fitzgerald, Richard Ji, Mary Meeker, Brian Pitz.
Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.
Global Research Conflict Management Policy
This research has been published in accordance with our conflict management policy, which is available at
www.morganstanley.com/institutional/research/conflictpolicies.
Important US Regulatory Disclosures on Subject Companies
The following analyst, strategist, or research associate (or a household member) owns securities in a company that he or she
covers or recommends in this report: Mary Meeker - Intuit (common stock), Amazon.com (common stock), Yahoo! (common stock),
Microsoft (common stock), eBay (common stock);. Morgan Stanley policy prohibits research analysts, strategists and research
associates from investing in securities in their sub industry as defined by the Global Industry Classification Standard ("GICS," which
was developed by and is the exclusive property of MSCI and S&P). Analysts may nevertheless own such securities to the extent
acquired under a prior policy or in a merger, fund distribution or other involuntary acquisition.
As of November 30, 2005, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following
companies covered in this report: Amazon.com, CNET, eBay, Google, priceline.com, Yahoo!.
Within the last 12 months, Morgan Stanley managed or co-managed a public offering of securities of Google, GSI COMMERCE.
Within the last 12 months, Morgan Stanley has received compensation for investment banking services from eBay, Google, GSI
COMMERCE, Intuit, Microsoft, priceline.com.
In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from
Amazon.com, CNET, drugstore.com, eBay, Google, GSI COMMERCE, Intuit, Microsoft, priceline.com, Yahoo!.
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investment banking services from CNET, Intuit, Microsoft, priceline.com.
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banking client relationship with, the following companies covered in this report: Amazon.com, CNET, drugstore.com, eBay, Google,
GSI COMMERCE, Intuit, Microsoft, priceline.com, Yahoo!.
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covered in this report: CNET, eBay, Intuit, Microsoft, priceline.com.
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competitive factors, firm revenues and overall investment banking revenues.
An employee or director of Morgan Stanley & Co. Incorporated and/or Morgan Stanley DW Inc. is a director of Microsoft, Yahoo!.
Morgan Stanley & Co. Incorporated makes a market in the securities of Amazon.com, CNET, drugstore.com, eBay, Google, GSI
COMMERCE, Intuit, Microsoft, priceline.com, Yahoo!.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.
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Different securities firms use a variety of rating terms as well as different rating systems to describe their recommendations. For
example, Morgan Stanley uses a relative rating system including terms such as Overweight, Equal-weight or Underweight (see
definitions below). A rating system using terms such as buy, hold and sell is not equivalent to our rating system. Investors should
carefully read the definitions of all ratings used in each research report. In addition, since the research report contains more
complete information concerning the analyst's views, investors should carefully read the entire research report and not infer its
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investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and
other considerations.
Global Stock Ratings Distribution
(as of November 30, 2005)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold,
and Sell alongside our ratings of Overweight, Equal-weight and Underweight. Morgan Stanley does not assign ratings of Buy, Hold
or Sell to the stocks we cover. Overweight, Equal-weight, and Underweight are not the equivalent of buy, hold, and sell but
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our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Underweight to hold and sell
recommendations, respectively.
Coverage Universe Investment Banking Clients (IBC)
Stock Rating Category Count % of Total Count
% of Total
IBC
% of Rating
Category
Overweight/Buy 740 36% 274 40% 37%
Equal-weight/Hold 940 45% 324 47% 34%
Underweight/Sell 386 19% 91 13% 24%
Total 2,066 689
Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on
individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are
companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.
Analyst Stock Ratings
Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's)
coverage universe, on a risk-adjusted basis, over the next 12-18 months.
Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry
team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.
Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry
team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.
More volatile (V). We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a
month, based on a quantitative assessment of historical data, or in the analyst's view, it is likely to become materially more volatile
over the next 1-12 months compared with the past three years. Stocks with less than one year of trading history are automatically
rated as more volatile (unless otherwise noted). We note that securities that we do not currently consider "more volatile" can still
perform in that manner.
Unless otherwise specified, the time frame for price targets included in this report is 12 to 18 months.
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Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be
attractive vs. the relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line
with the relevant broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution
vs. the relevant broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index; Europe - MSCI
Europe; Japan - TOPIX; Asia - relevant MSCI country index.
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performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the
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M O R G A N S T A N L E Y E Q U I T Y R E S E A R C H
Industry Coverage: Internet & Consumer Software
Company (Ticker) Rating (as of) Price (12/22/2005)
Brian Pitz
GSI COMMERCE (GSIC.O) E (08/05/2005) $15.53
Mary Meeker
Amazon.com (AMZN.O) O-V (03/18/2002) $49.22
CNET (CNET.O) E-V (03/18/2002) $15.09
drugstore.com (DSCM.O) E (03/18/2002) $2.68
eBay (EBAY.O) O-V (07/10/2002) $44.28
Google (GOOG.O) O-V (09/28/2004) $432.04
Intuit (INTU.O) O-V (03/18/2002) $53.73
Microsoft (MSFT.O) O-V (03/18/2002) $26.59
priceline.com (PCLN.O) E (03/18/2002) $23.14
Yahoo! (YHOO.O) O-V (03/18/2002) $40.83
Stock Ratings are subject to change. Please see latest research for each company.
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