Negative Share Price Drivers We believe the online ad market will contract by 4.6% due to the economic downturn.. We believe both the companies’ search ad revenue will still grow due to
Trang 1Our View on Share Prices
Despite Lower Trading Range, a Near-term Rebound Appears Less Likely
Korea’s Internet sector has underperformed the KOSPI by 27.5% for the past year — NHN and Daum fell 56% and 65%, respectively In particular, the shares fell sharply during August-September due to the emergence of regulatory risks After such a sharp correction, NHN has been holding up better, outperforming the KOSPI by 12% since early October, while Daum has underperformed by 3% We believe the weakness in Korea’s Internet sector largely stems from concerns about regulatory uncertainties and an economic slowdown
We expect these negatives to continue to dampen sentiment for the sector and its fundamentals for the next two to four quarters Although current valuations are at historical lows, we believe the market is largely reluctant to offer premium on growth stocks and is more sensitive to near-term earnings The trading range has
significantly lowered to 14-16x FY08E EPS for NHN and 13-18x FY08E EPS for Daum, while the 12-month historical average trailing P/E range is 20-50x for NHN and 40-80x for Daum
Figure 92: Korean Internet Sector Relative to KOSPI Performance
-40%
-30%
-20%
-10%
0%
10%
Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08
Internet sector to KOSPI NHN to KOSPI Daum to KOSPI
Source: Datastream
We believe both NHN and Daum lack near-term catalysts due to the weak economy and regulatory risks We think NHN will hold up better than Daum, since investors will likely prefer the market leader, given that advertisers on tighter budgets tend to lean towards the market leader to reap more benefits from their dollar spending We believe that although the downside for NHN should be limited at the current level, the stock is unlikely to rebound in the near term unless the market is convinced of an economic recovery We believe Daum’s share price will be largely volatile and could carry more downside risk as the company has relatively less earnings visibility and is more sensitive to the economy
Our Price Targets Are Based on a 10-year DCF Valuation
We derive our price targets using DCF, because the companies consistently generate recurring free cash flows from operations and there is no major change in the capital structure We use a 10-year DCF model with a 5.8% risk-free rate, 0% terminal growth rate and 12.7% WACC for NHN and 14.3% for Daum Our 10-year DCF model yields fair values of W130,000 for NHN and W33,000 for Daum For Daum,
we applied a 20% discount to our DCF-based fair value estimate to derive our price
Trang 2target of W26,000, as Daum is a relatively small company in the market and its operations are more sensitive to the economy
Valuations for Korean Internet companies remained at a 20-30% discount to their global peers until 1H07, but the gap almost disappeared in late 2007 and early 2008 when Korean Internet share prices rallied due to unprecedented earnings growth During the recent market weakness, however, the gap with the global peers widened again to the 10-20% level, which we believe will continue until regulatory
uncertainties disappear and the next round of growth story begins in Korea
Figure 93: NHN-TTM Trailing P/E Bands
Won
0
50,000
100,000
150,000
200,000
250,000
300,000
30x 20x 10x
Source: Company data, J.P Morgan estimates
Figure 94: Daum-TTM Trailing P/E Bands
Won
0 20,000 40,000 60,000 80,000 100,000
Sep-06 Jan-07 May -07 Sep-07 Jan-08 May -08 Sep-08
10x
Source: Company data, J.P Morgan estimates
Figure 95: Global Internet Companies’ EPS CAGR vs 08E P/E
NetEase
NCSOFT
Electronic Arts
Ebay
Amazon
Alibaba.com Yahoo Japan
NHN
Daum Comm
Yahoo
Baidu Tencent
Sohu
SINA
0.0 5.0 10.0 15.0 20.0 25.0 30.0
EPS CAGR(08E-10E), %
Source: Company data, J.P Morgan estimates Note: Price as of 28 Nov 2008
Negative Share Price Drivers
We believe the online ad market will contract by 4.6% due to the economic downturn Korea’s domestic ad market has constituted about 1% of GDP, on average, for the past 15 years Given the ad market has historically reacted more sharply to GDP growth and the ad market-to-GDP ratio tends to fall below 0.8% in a downturn, in FY09, the domestic ad market will contract 15% Y/Y, by our estimate Contrary to the consensus view that the online ad market will continue to grow, backed by advertisers’ heavy-weight online ads, we estimate that the online ad market will
Trang 3shrink by 3%, although the magnitude of the scale-down should be less than that of the total domestic ad market We believe the biggest weakness will stem from display ads, which could result in a 12% drop in the combined revenue of NHN and Daum We believe both the companies’ search ad revenue will still grow due to the market share shift towards performance-based advertising, although the growth could slow significantly to 12% in FY09, from 61% in FY07 We believe NHN will weather the economic slowdown better as advertisers are likely to opt for the portal with the largest market share, where the possibility of ads hitting target customers is higher
Stricter Regulations Likely to Dampen Sentiment
Koreans are among the heaviest users of Internet portals for participating in various discussion boards Since portals have played an influential role in forming public opinion in events such as the presidential election and the US beef case, some portals have been criticized for sorting and posting news reports that favor certain interest groups In addition to the political bias, certain portals’ accountability for their users’ defamatory posts has been actively discussed As a result, regulators and political parties are in favor of stricter controls on portals We believe the implementation of regulations will dampen sentiment on the Internet sector as it reflects the
government’s strong intent to apply stricter rules on portals and Internet users’ activities More importantly, rigid control could hurt user traffic and portals’
revenues, in our view
Recovery in 4Q Likely to Be Weak after Disappointing 3Q Results
NHN’s revenue and operating profit in 3Q declined Q/Q for the first time in the past four years The weak economy and change in online game rules led to the 4% and 13% Q/Q drop in the portal’s revenue and operating profit, respectively Daum’s revenue and operating profit fell 1.3% Q/Q and 4.7% Q/Q, respectively, mainly due
to its higher dependence on display ads, advertisers’ preference for bigger portals, and management’s quality initiatives We expect a recovery in 4Q to be weak despite seasonality, as companies are likely to reduce their ad budgets further, and Y/Y growth of the e-commerce market is unlikely to be exciting
Positive Share Price Drivers
Development of Rich Media Ads Should Increase the Unit Price of Banner Ads
Managements of NHN and Daum stated that their unit pricing for rich media banner ads—which use expansion ads, pop-up pictures or moving pictures—is about 20-200% more expensive than for a static ad, depending on the ad type According to NHN, rich media ad revenue accounts for about 25% of its banner ads (versus 8~15% for Daum) and this continues to grow Such ads are mainly adopted by large-scale advertisers, which can afford a higher unit price However, portals continue to develop new types of rich media ads, and we expect more advertisers to
accommodate these new formats Hence, we believe rich media will be a key driver for the Internet advertising market over the next few years
Diversification of Revenue Mix
We expect portals’ revenue mix to continue to diversify as contributions from ecommerce and gaming businesses increase For NHN, gaming accounted for 30% of sales as of 3Q08 versus 23% in FY06, while Daum’s e-commerce revenue accounted for 14% of total revenue as of 1Q08 versus 9.5% in FY06 Although gaming and ecommerce revenues account for smaller shares of total revenue than online ads, we
Trang 4believe it is a meaningful development for them to have an additional strong growth driver, as in our opinion it creates a more balanced and diversified business model
Trang 5U.S Company Previews
Trang 7Amazon.com, Overweight, ($50.76)
We are upgrading Amazon.com to Overweight from Neutral Although we believe a tough consumer environment may hamper spending in the near term, in the medium
to longer term, we see Amazon continuing to take share within eCommerce even as eCommerce continues to outpace overall retail growth Our 12-month price target for AMZN is $65
• Amazon is a net share gainer eCommerce is gaining share – and Amazon is
gaining share within eCommerce Through the first 9M’08, US retail sales rose 2%, US eCommerce grew 8%, and Amazon North America retail revenue was up 31% Y/Y We expect these relative trends to continue through F’09, with
eCommerce growing faster than retail and Amazon outgrowing eCommerce
• Amazon is diversifying its business The company has added more product lines
(e.g., office products), continues to expand its geographic footprint, and is aggressively pursuing revenue streams not derived from physical sales from inventory: third-party sales, digital media sales and Web Services We think Amazon is establishing itself as an unmatched online marketplace, and its higher-margin non-retail businesses could boost profitability in the medium to long term
• Low Cap-Ex model driving solid FCF generation Since 2Q’07, Amazon’s
TTM CapEx has been at or below 25% of operating cash flow, a trend we expect
to continue While we think operating margins are likely to stay in the 5% range
in the medium term, we believe Amazon can continue to produce solid FCF
growth, up 57% in F’09 and 42% in F’10
• 2009 drivers In our view, the following factors will drive shares in 2009: (1) the
impact of the economy on retail and eCommerce spending, both in the US and abroad, (2) Amazon’s ability to take share within eCommerce, (3) the impact of brick-and-mortar retail bankruptcies, and (4) customer uptake of digital download and web services businesses
• Adjusting 4Q’08 estimates We are lowering our 4Q’08 revenue, EBITDA and
EPS estimates, to $6.25B, $376M and $0.35 (from $6.65B, $407M and $0.40), as
we expect the tough environment to result in slower revenue growth and add pricing pressure this quarter; we are also lowering our F’09 revenue, EBITDA and EPS forecasts due to our anticipation of a longer, deeper recession that we previously saw Our F’08 – F’10 estimates are in the table below:
Table 84: Amazon.com Financial Snapshot
$ in millions, except per share data
J.P Morgan
Consensus
Source: J.P Morgan estimates, Company data, and Bloomberg
Trang 8Takeaways from the J.P Morgan Internet Team’s 2008 Consumer Survey
Amazon Emerging as the Clear Leader in US eCommerce
In our November 2008 survey, we asked those who shop online which stores they expected to buy from this holiday season Nearly 50% of online shoppers said they planned to shop at Amazon.com during the holiday season, and the expected reach for Amazon was 39% higher than that of its nearest competitor
Additionally, Amazon continues to do extremely well in terms of reach among those who earn $100K or more, with 59% of shoppers in that income category saying they had shopped there No other online retailer in our survey had a penetration higher than 33% with the over-$100K income bracket
Figure 96: Amazon’s Reach with Higher-Income Users Is Unparalleled, above 50%
% of online shoppers in each income group who made a holiday purchase from site in '07
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
Amazon eBay Walmart.com Target.com
<$25K $25K-$49K $50K-$74K $75K-$99K $100K+
Source: J.P Morgan Internet Team 2008 Consumer Survey
Our Estimates and Outlook for 2009
Despite our long-term optimistic outlook for Amazon, we believe an unfavorable consumer spending environment is likely to depress revenue growth in the first half
of the year As such, we are reducing our F’09 revenue growth rate assumptions; we now expect North America revenue to grow 14% Y/Y (from 17% previously and 26% in F’08E), as we expect EGM revenue growth to slow to 20%, from 39% in F’08E Internationally, we are now projecting 17% Y/Y growth, from 19%
previously and 32% in F’08E Our new revenue estimate is thus $22.0B, from
$22.5B, implying a 15% Y/Y growth rate
Due to the difficult pricing environment, we see gross margin in F’09 at 21.4%, down ~70 bps Y/Y We do not think Amazon will be able to significantly rationalize any of its operating expense lines, and thus think much of the gross margin
contraction will flow through to the operating margin line: we expect a ~61 bps operating margin decline Y/Y to 4.8%
Our model now calls for EBITDA in F’09 of $1.43B, down from $1.56B previously and up 1% Y/Y We are cutting our F’09 EPS estimate to $1.22, from $1.43
Trang 9Our Estimates and Outlook for 2010
We think a recovery in consumer spending is not likely until 2H’09 and believe that
a rebound in F’10, as well as easier comps from the depressed levels of 1H’09 could set up accelerating revenue growth at Amazon in F’10 We are modeling 19% Y/Y revenue growth in F’10 to $26.2B; we think both North America and International revenue growth could be faster in F’10 than F’09
Our model calls for EBITDA of $1.73B, slight Y/Y operating margin expansion to 5.0%, and EPS of $1.54
We Are Introducing a Price Target of $65
In introducing price targets for our coverage, we have derived multiples based on 5-year forward EBIT CAGRs We believe the historical record does not provide a meaningful guide to valuation as (a) the majority of the companies in our coverage did not have a track record as public companies through the previous recession; and (b) even the public companies were still in their early-growth (and, for some, rapid growth) stage during the last economic downturn
As such, given our projection for Amazon of a ~38% F’09-F’14 EBIT CAGR, and our view of the beginning of a possible economic turnaround in 2H’09, we believe the stock can achieve a 38x EV/EBIT multiple to our F’09 EBIT estimate (reflecting better forward visibility than the current valuation of 29x our F’09 estimate) and thus arrive at our December 2009 price target of $65
The parameters of our EV/EBIT multiple analysis are in the table below:
Table 85: Key Valuation Assumptions
Implied Enterprise Value $ 26,416
Source: Company reports and J.P Morgan estimates
Our EV/EBIT valuation is based on the following projections for revenue and operating income growth
Table 86: Growth Profile
$ in millions
2009E 2010E 2011E 2012E 2013E 2014E Revenues 21,693.5 26,165.1 31,528.7 37,676.5 44,646.3 52,146.9
Less: Operating Expenses 20,989.3 25,239.8 30,299.1 35,905.7 42,146.1 48,684.3
Operating Income (Loss) 704.2 925.3 1,229.6 1,770.8 2,500.2 3,462.6
Source: Company reports and J.P Morgan estimates
Trang 10Valuation and Rating Analysis
AMZN trades at a premium to its peers Our updated F’09 assumptions yield a 2009 EV/EBITDA multiple of 14.5x our F’09 EBITDA estimate of $1.42B, versus the ecommerce group at 6.5x and its large-cap peers at 7.8x Given the rapid revenue growth and superior industry position, we believe the stock has capacity to see further multiple expansion and thus rate AMZN Overweight
Risks to Our Rating
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 Amazon could suffer if consumer spending continues weakening or remains depressed longer than we expect Amazon faces competition from a variety of online and offline retailers, and improved offerings from these competitors could hamper Amazon’s growth