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Thoughts on the Internet & China (49 pages)
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Thoughts on the Internet & China
Hua Yuan 2005 Annual Conference – 5/7/05
mary.meeker@morganstanley.com
richard.ji@morganstanley.com
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. Please see our research
reports for detail on companies under coverage.
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Outline
• Perspective
• General Trends
• China and the Internet
• Summary
• Attributes of Winning Companies
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Perspective
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What We Have Lived Through with Internet
Company Creation Bust Boom-let
Wealth Creation Bust Boom
Patterns
Boom
Boom-let
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Top 5 Global Internet Market Cap Leaders
• $ 2B = market value - pre-2000 IPO
• $178B = market value - Nasdaq peak – 3/10/00
• $ 32B = market value - Nasdaq trough – 10/9/02
• $210B = market value - 5/2/05
Google + Yahoo! + eBay + Yahoo! Japan + Amazon.com
Google included after company’s 8/04 IPO.
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Internet 24x7…Everywhere
Patagonia 7 Miles Above North Sea
From: Peter Bloom
To: Mary Meeker
Sent: Fri Apr 15 11:04:43 2005
Subject: Amazing paradigm shift at 36,000
feet...the world really is getting smaller!
I am currently 7 miles above the earth on an
SAS flight somewhere over the North Sea. I
am writing this email from one of the first
planes to have a high speed continuous
connection to the Internet. I am connected
using standard wireless access and in
addition to email I have three IM sessions
running with instantaneous response and also
just executed a trade on NASDAQ. [I plan to
make a VoIP call later.]
Truly awesome implementation of
technology...but sadly the last haven from
"the connected world" has now been
obliterated. Someday we'll all take emails
like this for granted but I couldn't pass up
the opportunity to send one of the first
ones.
Coming up on Greenland!
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Global Data Points…
Google
Broadband
Yahoo!
Digital Music
Yahoo!
Blogging
5B global searches (+62% Y/Y, 2/05); 355MM global unique visitors
(+36%, 2/05) per comScore
135MM global subscribers (+51% Y/Y, CQ4); 39MM in N. America;
63MM in Asia
917MM streaming video (music…) sessions (+119% Y/Y, CQ4)
300MM cumulative iTunes (+270%, CQ1 to 100MM); 16MM iPods;
digital music = 15% of US music units sold in 2004
40MM+ estimated My Yahoo! users
27% of US Internet users indicated they read blogs
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…Global Data Points
Wireless Internet 196MM messaging subscribers (CQ4) in China, No. 1 in world
VoIP 33MM registered Skype users (4/05) - fastest product ramp ever?
Shanda
Networking
2MM peak concurrent online gamers (+69% Y/Y, CQ4) in China
PayPal 72MM accounts (+57% Y/Y, CQ1); 22MM users (+52%)
Mobile Payments Dutch Railways rolling out SMS ticketing for trains
Global N. America = 26% of Internet users in 2004; was 46% in 1998
S. Korea Broadband penetration of 70%+ - No. 1 in world
China More Internet users < age of 30 than anywhere
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General Trends
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900MM+ global customers driving on same
highway with same information at same time
Only differences: speed; language; device
(mobile, PC…)
Making inefficient markets efficient – eBay
360° of Engagement
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Broadband Ramp in 25-30% Penetration Sweet Spot…
Morgan Stanley Research.
0
10
20
30
40
50
60
70
80
2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E 2011E
US Residential Broadband
Subscribers (MM)
0%
10%
20%
30%
40%
50%
60%
% of Total US Households
US Residential Broadband Subscribers % of Total US Households
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Content / User Experience Continues to Improve…
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…Content / User Experience Continues to Improve
Consumer Satisfaction with Merchants in CQ4 Holidays
50%
29%
18%
2% 1%
58%
28%
12%
1% 0%
73%
22%
3% 2% 0%
0
10
20
30
40
50
60
70
80
Very Satisfied Somewhat
Satisfied
Neither Somewhat
Dissatisfied
Very
Dissatisfied
Percent Selecting Response
2002 2003 2004
Shop.org/BizRate Research Online Holiday Mood Study
BizRate Research, a Division of Shopzilla
Conducted By Shop.org and BizRate Research
Wave 2 Dates
2002: 12/2 – 12/3
2003: 12/1 – 12/2
2004: 12/6 – 12/7
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Mobile Increasingly Important
Mobile
Phone to
Internet
Country User Ratio
Mobile
Phones
(MM)
Internet
Users
(MM)
Installed
PCs
(MM)
China
US
Japan
Germany
UK
Italy
S. Korea
334
180
94
68
54
54
34
94
201
68
42
30
26
30
3.6 : 1
0.9 : 1
1.4 : 1
1.6 : 1
1.8 : 1
2.1 : 1
1.1 : 1
42
204
54
40
26
15
27
Euromonitor, CNNIC, World Bank, Morgan Stanley Research – 2004 year-end data
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Hierarchy of Needs?
Selfactualization
Esteem
Belonging
Safety
Physiological
Created for discussion purposes and perhaps a bit of humor. Not intended to discredit Maslow’s hierarchy of needs which we believe to be accurate.
1943 - Maslow 2005 - ? ;)
Internet /
Mobile Phone
Shelter
Food / Water
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Our mission is to organize all the world’s
information and make it universally accessible
and useful. - Google
‘All the World’s Information…’
Mmm, this may be doable well before most of
folks in this room retire
Think about ~$500MM in annual capex and
universal language translation on the fly
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10-15% user growth
20-30% usage growth
30%+ monetization growth
Global Internet Thesis
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China and the Internet
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• Most populous country – 1.3B people (21% of world)
− 1850 – 33% of global GDP
− 1991 – < 2% of global GDP
− 2004 – 4% of global GDP (or 13% using PPP)
• Top priority for China’s leaders is long-term, sustainable economic growth
with relatively high levels of employment
• Technology is designated vehicle for driving growth; Internet at core of
technology innovation
− Internet connectivity may help Chinese companies more effectively utilize
labor and resource base locally and globally
• Many disruptive forces / challenges / risks in China
Internet as Change Agent for China
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Acceptance of Internet in China is Impressive
• Mobile / Internet markets robust
− #1 in world – mobile phone users (340MM, 2004)
− #1 in world – Internet users under 30 (65 MM, 2004)
• China lags in e-commerce / advertising, leads in games / mobile services
− Top 5 online games – 120K+ avg. concurrent users, 2x leaders in US /
Japan / Korea
− $3.8B (+96% Y/Y, 2004) wireless data services revenue for China Mobile,
16% of total revenue
• Internet creates value for China consumers
− NetEase – 600K peak concurrent users for leading game (5/05)
− Tencent – 9MM peak concurrent users for QQ instant messaging (CQ4)
− Sina – 20MM+ unique weekly readers of news
Sources: CNNIC, Morgan Stanley Research estimates.
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Most Trafficked Chinese Language Sites
Source: Chinese (simplified) rankings from www.alexa.com, 5/5/05. Note that Alexa’s traffic rankings are based on usage patterns of opt-in
users of Alexa’s downloadable toolbar. Alexa’s results may be skewed owing to inclusion of Alexa toolbar with ISPs in China.
Rank Site Name
1
2
3
4
5
6
7
8
Sina
Baidu
Sohu
NetEase
3721 / Yahoo!
QQ / Tencent
Tom Online
Taobao
Rank Site Name
9
10
11
12
13
14
15
16
Yisou / Yahoo!
21cn
Chinaren / Sohu
Vush.info
China.com
Hao123.com
eBay China
Allyes
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Internet Users Concentrated in Coastal Regions
and Major Metropolitan Areas
1.3%
Tianjin 2.1%
West China
18.8 %
Coastal China
(including Beijing,
Tianjin, Shanghai)
56.4 %
1.0 %
0.1 %
0.2%
5.6%
2.2%
3.0% 12.6 %
3.5%
5.7%
Shanghai
4.7%
7.0%
9.0%
3.4%
1.9%
2.9%
1.0%
3.3% 1.7%
4.6%
3.2%
2.6%
1.3%
2.2%
3.6%
2.8 %
0.5 %
Beijing
4.3%
0.3%
Source: CNNIC 15th Statistical Survey Report on the Internet Development in China, 1/05.
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Labor Advantage Remains Pronounced
• Annualized Opex per Employee
− $7K = China using Hang Seng Index (1) – Labor surplus!
− $73K = US using S&P500 (2)
− $298K = Microsoft
• GDP per Capita
− $623 = China
− $37K = US
Source: (1) Computed as sum of SG&A and R&D for 17 of 37 companies for which data was available. (2) Computed as sum of SG&A and R&D for 367 of
500 companies for which data was available. FactSet employee data for calendar 2004, employee data for year-end 2004.
…Government’s Focused on Ramping Internet,
in Part, to Boost Domestic and Global Trade…
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Cultural Evolution vs. Cultural Revolution
• Pre-Internet – gaping holes
− Information / News – regulated (top 10 newspapers state-owned…)
− Entertainment – only 8 ‘model’ movies during Cultural Revolution
− Interaction – one-child policy
• Post-Internet – filling in holes
− Portals (Sina / Sohu) – alternative news sources
− Online games (Shanda / NetEase) – entertainment
− Instant messaging (Tencent) / MVAS (Sina / Tom Online) – connectivity
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Increasing Foreign Entry - Just Starting?
• Acquisitions
− eBay / EachNet (#1 online auction)
− Yahoo! / 3721.com (#2 paid search)
− Amazon.com / Joyo (leading e-commerce provider)
• Investments
− InterActive / eLong (#2 online travel)
− Monster.com / ChinaHR (#2 online recruiting)
− Google / Baidu (#1 paid search)
• Partnerships
− NcSoft-Sina, Skype-Tom Online, Disney-Sohu
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China Internet M&A - Experimental Ground
• First ‘hostile’ share purchase - Shanda vs. Sina
• First ‘Poison Pill’ - Sina vs. Shanda
• Horizontal integration
− Sohu surpassed Sina traffic by acquiring ChinaRen / 17173.com /
Focus.net
− Shanda complemented core business via purchases of PC game /
mobile game / casual game companies
• Vertical integration
− Tom Online strengthened leadership in interactive voice response
(IVR) via purchase of Pucinni
− Sina jump-started MVAS (60% of its 2004 revenue) through
purchases of Memestar / Crillion
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Mobile-Centric vs. PC-Centric…
• Mobile users
− 340MM, 3.6x > than Internet users (2004)
• MVAS industry revenue
− ~$700MM-$800MM - 2x > online games; 3x > online advertising (2004)
Sources: CNNIC, Morgan Stanley Research estimates
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…Mobile-Centric vs. PC-Centric
Source: Morgan Stanley Estimates for 2004.
TMT Category
China Global
Ranking
China
Units (MM)
China
Growth
Mobile Phones
Cable TV Subscriptions
Telephone Lines
Internet Users
Installed PCs
334
122
283
94
42
1
1
1
2
3
27%
10
14
18
17
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Source: Company Reports; totals may not add to 100% owing to rounding errors. (1) Operating margin excludes stockcompensation
and amortization expense. (2) CQ4:04 results.
China Internet Portal Revenue Breakdown
Shanda (2)
Sina
NetEase
Tencent
Tom Online (2)
Sohu
--
58
6
93
93
25
Company Revenue Messaging Gaming/Other Advertising
$52
46
40
38
34
24
91%
6
80
11
12
9%
36
14
66
63
(US$ in Millions) CQ1:05 % of Revenue
Total $234 44% 37% 20%
Margin (1)
Operating
42%
24
50
38
25
47
37%
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Signs of Category Concentration
• Online advertising
− Top 2 (Sina, Sohu), 55% share (2004)
• Online games
− Top 2 (Shanda, NetEase), 58% industry revenue (2004)
• MVAS
− Top 3 (Sina, Tom Online, Tencent), 41% share (2004)
• Instant messaging (IM)
− Tencent, 77% of IM users (2004)
• Online auctions
− eBay / EachNet & Taobao, 90%+ gross merchandise value (2004)
Sources: iResearch, Morgan Stanley Research estimates.
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SOEs - Referees AND Players
• State-owned Enterprises (SOEs) typically rule-makers
− China Mobile has ordered content clean-up, cancellation of inactive
accounts, and billing platform migration for MVAS (since CQ1:04).
• SOEs also players
− MVAS already accounted for ~16% of China Mobile revenue (2004)
• Challenges rise when SOEs are key to value chain
− Unlike online advertising and online games, mobile carriers lie
between MVAS providers and consumers
− Potential rise in revenue sharing by mobile carriers may hurt margins
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Challenges for Multinational Companies Create
Opportunities for Chinese Companies
• Chinese market is complex, especially for non-China companies
• Foreign investment is restricted and structuring and legal issues can be
daunting
• Internet is highly regulated
− Many (including Google) have been suspended for ‘improper’
content
• Local content is key to draw local consumers
− No online game with Western content has achieved much success
in China
• Entry into WTO is helping, but still long way to go…
• Muscle flexing by local companies can have significant impact – China
Mobile and China Unicom in MVAS…
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Premium Content, Premium Price
• Content providers gaining pricing power
− Tom Online paying out 50%-70% of revenue to music companies for
distribution rights
− KongZhong paid 5x more for wireless distribution rights for leading
blockbuster movie vs. 2 years ago
− Foreign game developers command 10x higher upfront licensing payment
vs. several years ago
• ISPs or ICPs?
− Internet companies transforming into content aggregators from service
providers under telecom carriers’ squeeze
• Rollouts of 3G / broadband services create demand for quality
content
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Risks - Expect the Unexpected
• Regulatory / government-related uncertainties
− Leaders of 3 telecom carriers shuffled among each other in late 2004
− Potential rise in revenue sharing by mobile carriers
• Industry risks - irrational business practices
− SMS - cleanup of inactive accounts
− MMS - suspension of services due to ‘push’ marketing (Sohu)
− WAP - fine due to spamming (KongZhong)
− IVR - sanction due to improper content (Sina)
• Management risks
− ‘Founder mentality’ - reluctance to delegate
− ‘Hallowing’ of middle-management
• Dearth of innovation, lots of intramural competition
• Infrastructure underdeveloped (billing / payment / logistics…)
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Major Drivers Trending Up
• Volume
Internet users
Broadband users
Mobile users
• ARPU
Internet users
Broadband users
• Industry Revenue
Online games
MVAS
Online advertising
94MM (+18% Y/Y, < 7% of population)
43MM (+146% Y/Y, < 3% of population)
340MM (+24% Y/Y, 26% of population)
$5-6 per month
$10-15 subscription fee per month
$391MM (+90% Y/Y)
$763MM (+35% Y/Y)
$227MM (+57% Y/Y)
2004 year-end
Source: Morgan Stanley Research Estimates.
CAGRe
next 3 years
11%
18
8
37%
27
24
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2005E
Revenue (1)
Source: Based on Conversion Rates as of 5/2/05, 1 US$ = 7.8 Hong Kong Dollars; (1) Based on I/B/E/S Consensus estimates. (2) For C2004, based on return
over IPO offering price for Shanda, Tom Online, KongZhong, Linktone, Tencent and 51job.
China Internet Company Comparables
Shanda
NetEase
Sina
Tencent
Ctrip
Sohu
Tom Online
51job
chinadotcom
KongZhong
Linktone
$32
49
27
1
43
17
12
17
377 $
2,214
1,582
1,409
1,223
679
626
562
481
294
245
172
$241
174
216
162
57
111
163
72
232
--
64
$100
92
64
69
24
33
49
13
3
--
14
286%
43
(5)
26
35
(41)
(2)
271
(43)
(4)
(40)
(26%)
(7)
(15)
27
(7)
(3)
(24)
(67)
(42)
(26)
(20)
Company Price Equity Value
2005E
Operating
Income (1)
(US$ in Millions, Except per Share Data)
2004 2005YTD
% Price Change (2)
Total $9,487
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Summary
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Internet in China
• Internet serving important role in helping modernize China and
drive efficiencies
• Still, small revenue / profit levels for China Internet companies
• Like US in mid-1990s, we are at the beginning…but, in many
respects, for China, impact may be greater
• Lots of opportunity with lots and lots of risk
• Andy Xie notes that… “In the middle of most small towns in
Europe or the US stands a church; in China, it is usually a
Kentucky Fried Chicken or a McDonald’s or both...”
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• Broadband
• Mobile
• User experience
• Search
• Personalization with more effective targeting
• User-generated content (RSS, blogs, reviews, images, audio…)
• Music
• Payments
• Short- and long-form video
• Local
• Pay per call
• Accessibility (PC + mobile…)
Global Internet Usage Growth Drivers
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You just heard you missed one of the greatest
golf shots in the history of the game. You want
see it and you are happy to pay to watch it or
perhaps view an ad in front of the footage.
You just want to watch it…
When Can We Do This?
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Google and Yahoo! Search Don’t Help
Search: Tiger Woods 16th hole Augusta video
• Lots of news stories
• No video
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Google & Yahoo! Video Search Don’t Help
Search: Tiger Woods 16th hole Augusta
• Pictures, text
• Not video we’re looking for
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What Does Help?
• Blogger posts video in the spirit of
creating a prototype Nike ad
• It’s downloadable, it’s free, but
potentially missing appropriate
permissions…
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The Shot!
Click on image to play video. Adobe® Acrobat® Reader® version 6.0 or greater required to play video clip. To download a
free copy, visit http://www.adobe.com/products/acrobat/readstep2.html
Source: Blogger (http://www.jaffejuice.com).
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We Want it, Make it Easy!
Content / Rights Owners
User searches for content Search Engines
Content owners receive payments via payment mechanism or ad
User gets content
Payment Mechanism Advertisements Such as…
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Impact of Internet has Just Begun
People have very little intuition for what it will
mean when the top 40% of US households,
based on income, have half a dozen computers,
all of them connected to the Net, all of them with
"instant on." They just don’t know how important
a part of our daily life the online world will be!
Jeff Bezos interview with Chip Bayers, Business 2.0
September, 2002
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Attributes of Winning Companies
1. Large market opportunities - it is better to have 10%, and rising, market share
of a $1 billion market than 100% of a $100M market
2. Good technology/service that offers a significant value/service proposition to
its customers
3. Simple, direct mission and strong culture
4. Missionary (not mercenary), passionate, maniacally-focused founder(s)
5. Technology magnets (never underestimate the power of great engineers)
6. Great management team / board of directors / committed partners
7. Ability to lead change and embrace chaos
8. Leading/sustainable market position with first-mover advantage
9. Brand leadership, leading reach and market share
10.Global presence
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Attributes of Winning Companies
11. Insane customer focus and rapidly growing customer base
12. Stickiness and customer loyalty
13. Extensible product line(s) with focus on constant improvement and
regeneration
14. Clear, broad distribution plans
15. Opportunity to increase customer “touch points”
16. Strong business and milestone momentum
17. Annuity-like business with sustainable operating leverage assisted by
barriers-to-entry
18. High gross margins
19. Path to improving operating margins
20. Low-cost infrastructure and development efforts
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