Sohu, Overweight, $46.22 We maintain our Overweight rating on Sohu, which also remains our top pick in the online advertising sector in China.. Sohu also plans to launch three new games
Trang 1Table 218: SINA Annual Cash Flow Statement
$ in millions
Add Non cash Expenses/(income)
Depreciation and Amortization 15 16 21 27
Other Non-Cash Items/Share base comps 9 15 16 16
Changes in Working Capital:
(Increase)/Decrease Receivables -12 -19 -17 -24
(Increase)/Decrease Inventories 0 0 0 0
(Increase)/Decrease Other Current Assets 1 -17 -6 -8
Increase/(Decrease) Payables -1 5 1 2
Increase/(Decrease) Other Current Liabilities 17 8 17 23
Cash Flow from Investing
Purchase of Property, Plant & Equipment -13 -12 -30 -35
Purchase/Sale of Other LT assets (Goodwill) -1 0 0 0
Others (incl Chg in short-term investment ) -6 0 0 0
Cash Flow from Financing
Issuance/Repayment of Debt -1 0 0 0
Change in other LT liabilities 1 -1 0 0
Change in Common Equity - net 20 10 11 11
Other Financing Charges, Net 21 0 -1 -3
Source: Company reports and J.P Morgan estimates
Trang 2Sohu, Overweight, ($46.22)
We maintain our Overweight rating on Sohu, which also remains our top pick in the online advertising sector in China Our Jun-09 price target is US$100, which implies 26.6x FY08E and 20.9x FY09E GAAP EPS, or 24.8x FY08E and 19.8x FY09E adjusted diluted EPS
• Sohu remains among the leading Internet portals in China, and is likely to remain among the key beneficiaries of the continued uptrend in online advertising in China Although China GDP growth is likely to slow to 8-9% in 2009, we expect Internet penetration (currently ~20%) to grow to ~24% in 2009, and drive online
ad revenue growth by at least 20% We believe with improving execution and better brand awareness (having been the official Beijing Olympics Internet content sponsor), Sohu can continue to deliver solid online ad growth going forward In addition, the company continues to expand its original content, such
as exclusive interviews (video and text), video content, and deeper content verticals coverage
• The continuing success of Sohu’s online game TLBB remains an additional growth driver for the company (with beneficial impact on revenues and margins) TLBB registered users were at 39.4 million in 3Q08, with active paying accounts
of 1.86 million We expect continued strong long-term growth for TLBB, and expect 3Q08 and future upgrade packs to be drivers for 4Q08 and 2009 TLBB’s strong brand name in China will help the game to further penetrate into lower-tier cities Sohu also plans to launch three new games in 2H09, besides an upgrade pack for existing game Blade Online in 2Q09, which should further boost online gaming revenue International game licensing fees (currently from HK, Taiwan and Vietnam) are also expected to contribute incremental revenue
• 2009 drivers: In our view, the following factors will drive shares in 2009: (1)
slightly better visibility on 2009 ad budget growth by early ‘09, (2) continued solid execution in both online ad and online gaming, (3) potential upside from new games in 2H09, and (4) share buyback program of up to US$150MM until the end of 2009 (Sohu has US$279MM in net cash as of 3Q08)
Our current and newly introduced 2010 estimates are in the table below:
Table 219: Sohu Financial Snapshot
$ in millions, except per share data
J.P Morgan
Revenue 120.9 428.4 527.6 625.0 127% 23% 18% EBITDA 56.3 189.6 240.6 282.9 262% 27% 18% GAAP EPS 1.16 3.76 4.78 5.60 314% 27% 17% Adj EPS 1.23 4.04 5.05 5.87 256% 25% 16%
Consensus
Revenue 120.4 427.5 529.2 613.9 126% 24% 16% EBITDA 53.8 187.2 234.0 281.5 257% 25% 20% GAAP EPS 1.14 3.73 4.50 5.13 311% 21% 14% Adj EPS 1.25 3.92 4.70 5.22 246% 20% 11%
Source: J.P Morgan estimates and Bloomberg *Note: Adj EPS excludes share-based compensation expense
Trang 3Our Estimates and Outlook for 2009
We forecast net revenue of US$527.6MM in 2009, up 23% Y/Y, and GAAP diluted EPS of US$4.78, up 27% Y/Y, or adjusted EPS (ex-share-based expense) of US$5.05, up 25% Y/Y We forecast 2009 brand advertising revenue of US$207.3MM (39% of total revenue), up 22% Y/Y, and online game revenue of US$249.1MM (47% of total revenue), up 24% Y/Y For the wireless related segment, we forecast revenue of US$63.7MM (12% of total revenue), up 34% Y/Y
On margins, we forecast gross margin at 74.7% for 2009, slightly below 75.3% for
2008 Our online game gross margin forecast is 89.1% in 2009, slightly lower than 92.0% for 2008, and our advertising gross margin forecast is 65.7%, up from 63.6% for 2008 (due to lower content costs in 2009) We expect adjusted operating margin (ex-share-based expense) of 42.2% for 2009, up from 40.8% for 2008, and adjusted net margin of 38.1% for 2009, up from 37.0% for 2008
Our Estimates and Outlook for 2010
For 2010, we forecast net revenue of US$625.0MM, up 18% Y/Y, and GAAP diluted EPS of US$5.60, up 17% Y/Y, or adjusted EPS of US$5.87, up 16% Y/Y We forecast 2010 brand advertising revenue of US$272.0MM, up 31% Y/Y, and online game revenue of US$277.3MM, up 11% Y/Y On margins, we forecast gross margin
at 74.0% (slightly lower Y/Y); adjusted operating margin of 41.8% (stable Y/Y) and adjusted net margin of 38.1% (also stable Y/Y)
Price Target, Valuation and Rating Analysis
We maintain our Overweight stance on Sohu, which also remains our top pick in the online ad sector in China Our price target for Sohu is US$100 (Jun-09), which implies 26.6x FY08E and 20.9x FY09E GAAP EPS, or 24.8x FY08E and 19.8x FY09E adjusted diluted EPS; the price target is based on the midpoint of our sum-of-the-parts valuation of US$87.8-US$111.2 Our Jun-09 DCF valuation for Sohu is US$97, based on a 10-year DCF forecast, WACC of 12%, and terminal growth rate
of 0%
Risks to Our Rating and Price Target
Risks to our rating and price target include a greater slowdown in the Chinese economy that could result in lower online advertising revenue growth, significant market share loss in online advertising to other websites, uncertainty in wireless revenue due to policy change at mobile operators, any significant delays in upgrade launches for existing online games, and unsuccessful new games
Trang 4Table 2: SOHU Annual Income Statement
$ in millions
INCOME STATEMENT
2007 2008E 2009E 2010E
Operating Expense -93.1 -158.7 -182.0 -211.9
Adj EBIT (ex- 123R expense) 41.5 174.7 222.9 261.6
Net Interest Income 2.8 4.3 6.7 10.9
Pre Tax Profit 36.4 167.5 218.6 261.4
Tax Expense/(Credit) -1.5 -20.1 -28.7 -34.1
Margins (%)
Operating Margin (ex- 123R exp.) 22.0 40.8 42.2 41.8
Adj Net Margin (ex- 123R exp.) 23.1 37.0 38.1 38.1
Sequential Growth (%)
Source: Company reports and J.P Morgan estimates
Trang 5Table 220: SOHU Quarterly Income Statement
$ in millions
1Q'07 2Q'07 3Q'07 4Q'07 1Q'08 2Q'08 3Q'08 4Q'08E 1Q'09E 2Q'09E 3Q'09E 4Q'09E
Net Profit (excl 123R option expense) 7.0 8.1 11.7 17.0 25.1 42.3 42.822 48.2 45.5 49.1 52.2 54.1
EPS Diluted (US$ excl 123R option expense) 0.18 0.21 0.31 0.43 0.64 1.07 1.08 1.23 1.16 1.24 1.31 1.35 Margins (%)
Sequential Growth (%)
Source: Company reports and J.P Morgan estimates.
Trang 6Table 221: SOHU Annual Balance Sheet
$ in millions
Total Other Current Assets 8 48 56 66
Accumulated Depreciation -28 -42 -59 -80
Long Term Investments and Associates 0 0 0 0
ST Debt and Current Portion of LT Debt 0 0 0 0
Other Current Liabilities 69 121 141 166
Other Long Term Liabilities 0 3 3 3
Source: Company reports and J.P Morgan estimates
Trang 7Table 222: SOHU Annual Cash Flow Statement
$ in millions
Add Non cash Expenses/(income)
Depreciation and Amortization 11 15 18 21
Changes in Working Capital: 0 0 0 0
(Increase)/Decrease Inventories 0 0 0 0
(Increase)/Decrease Other Current Assets 3 -41 -8 -10
Increase/(Decrease) Payables 1 1 1 1
Increase/(Decrease) Other Current Liabilities 32 52 20 25
Cash Flow from Investing
Purchase of Property, Plant & Equipment -53 -29 -38 -46
Purchase/Sale of Other LT assets /intanbgible assets 2 -1 0 0
Purchase/Sale of Investments 1 0 0 0
Cash Flow from Financing
Issuance/Repayment of Debt -60 0 0 0
Change in other LT liabilities 0 3 0 0
Change in Common Equity - net 19 28 16 18
Other Financing Charges, Net 0 0 0 0
Net Effect of Exchange Rate Changes 0 0 0 0
Source: Company reports and J.P Morgan estimates
Trang 8The9, Overweight, ($13.68)
We maintain our Overweight rating on The9 on what we view as cheap valuation, as the stock is trading around cash (on the back of market concerns about game license renewal and delays in new game launches) and we expect the company to continue with positive cash flow generation Our Jun-09 price target is US$18, which implies 9.2x FY08E and 11.4x FY09E GAAP EPS, or 8.1x FY08E and 9.3x FY09E adj
EPS
• The9’s flagship game World of Warcraft (WoW, ~92% of total revenue) disappointed in 3Q08 with a revenue decline of 10% Q/Q (with average concurrent users at 416k, down from 489k in 2Q08) on the back of greater than expected negative impact from the Olympics and negative Q3 seasonality The9’s two main item-based games, Sun and GE, also continued to deliver largely disappointing results Further, The9’s growth outlook remains relatively uncertain, due to: (1) The9 is still in the process of negotiating with Blizzard (developer of WoW) on the license renewal for WoW; (2) FIFA Online 2 has yet
to obtain government approval (already delayed a few quarters); (3) WoW’s next upgrade, Wrath of Lich King, is still in the process of obtaining government approval; and (4) other games such as Hellgate: London and Huxley now seem to
be delayed to late 2009 or beyond
• On the positive side, The9 still possesses a diversified game pipeline of casual games (FIFA Online 2 and Audition 2), licensed MMORPGs (Hellgate: London, Huxley, Atlantica, RO2, etc.) and in-house games (MJSG and FM Online) We also believe The9 still has the highest chance to obtain the renewal license for WoW, since The9 has cumulatively invested more than US$60MM in WoW servers over time, and we believe The9 still has a decent relationship with Blizzard Therefore, we believe the partnership would likely continue, even though with likely higher revenue sharing Further, despite positive cash flow generation, the stock is currently trading almost at cash
• 2009 drivers: In our view, the following factors will drive shares in 2009: (1) the
launch of new games such as FIFA Online 2 and Audition 2, (2) the renewal of WoW’s license, which is set to expire in June ‘09 (WoW still represents ~92% of The9’s revenue), and (3) share buyback of up to US$50MM over the next few quarters (The9 ended 3Q08 with US$330MM in cash and short-term
investments)
Our current and newly introduced 2010 estimates are in the table below
Table 223: The9 Financial Snapshot
$ in millions, except per share data
J.P Morgan
Revenue 65.8 254.9 309.4 363.7 50% 21% 18%
EBITDA 28.1 103.2 128.7 141.7 57% 25% 10%
GAAP EPS 0.36 1.95 1.58 1.48 69% -19% -6%
Adj EPS 0.45 2.23 1.94 1.84 61% -13% -5%
Consensus
Revenue 57.7 238.8 291.1 330.3 41% 22% 13%
EBITDA 23.9 94.2 95.9 90.5 43% 2% -6%
Trang 9Our Estimates and Outlook for 2009
We forecast net revenue of US$309.4MM in 2009, up 21% Y/Y, and GAAP diluted EPS of US$1.58, down 19% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.94, down 13% Y/Y We forecast WoW revenue of US$233.0MM in 2009 (~75% of total revenue, down from over 90% in 2008), flattish Y/Y, while we expect revenue contribution to begin from several of The9’s new games (such as FIFA Online 2, Audition 2, Atlantica, MJSG, FM Online, Hellgate: London, Huxley, etc.)
We forecast gross margin at 42.2% for 2009, down from 45.6% for 2008 due to assumption of higher revenue share for WoW (30% from 2H09 vs 22% in 2008)
We expect adjusted operating margin (ex-share-based expense) of 20.4% for 2009, down from 25.1% for 2008, and adjusted net margin of 17.5% for 2009, down from 24.4% for 2008
Our Estimates and Outlook for 2010
For 2010, we forecast net revenue of US$363.7MM, up 18% Y/Y, and GAAP diluted EPS of US$1.48, down 6% Y/Y, or adjusted EPS of US$1.84, down 5% Y/Y On margins, we forecast gross margin at 39.0% (down Y/Y with full-year impact of higher revenue share for WoW); adjusted operating margin of 16.7% (down Y/Y) and adjusted net margin of 14.2% (also down Y/Y)
Price Target, Valuation and Rating Analysis
We maintain our Overweight rating on The9 on what we view as cheap valuation, as the stock is currently trading close to cash value per share (~US$12/share) Our price target is US$18 (June-09), which implies 9.2x 2008E, or 11.4x 2009E GAAP EPS, and 8.1x 2008E, or 9.3x 2009E adjusted EPS Our price target is below our DCF valuation of ~US$36 (WACC of 12.8% and terminal growth of 0%) due to the current stock market environment and company-specific uncertainties in the near term (game launch delays, WoW license renewal) The9 has net cash of ~US$12 per share; excluding cash, our price target implies 4.3x 2008E and 4.8x 2009E adjusted EPS, which is at the low end of its historical trading range
Risks to Our Rating
Risks to our rating and price target include (1) the company being unable to obtain second-term WoW license, or being required to pay a significant royalty / upfront fee, (2) lower-than-expected WoW revenue growth, (3) uncontrolled marketing spending, and (4) lower-than-expected acceptance of upcoming titles
Trang 10Table 224: NCTY Annual Income Statement
$ in millions
2007 2008E 2009E 2010E
Operating Expenses -45.6 -60.2 -77.3 -90.9
Share-based compensation -6.4 -7.8 -10.0 -10.0
Equity earnings in affiliates -0.8 -0.3 -0.5 -0.5
Pre Tax EPS (US$) 1.21 2.14 1.78 1.67
After Tax EPS (US$) 1.17 1.96 1.60 1.50
Margins (%)
Operating Margin (excl 123R option expense) 22.2 25.1 20.4 16.7
Net Margin (excl 123R option expense) 22.6 24.4 17.5 14.2
Sequential Growth (%)
Pre Tax Profit -13.9 77.5 -16.9 -5.6
After Tax EPS Diluted -27.9 69.0 -19.2 -6.2
After Tax EPS Diluted excl 123R option exp -18.7 61.0 -13.3 -5.2
Source: Company reports and J.P Morgan estimates