China Internet Sector

Information Technology / China 14 August 2015

Online video: why the content China Internet Sector creators will be kings Positive (unchanged) • Rising value for content creators; large Internet players likely to Neutral transform into entertainment conglomerates in the long term Negative • Advertising to remain the major revenue source; too early to call

an inflection point for the subscription model • Reiterating Buy (1) calls on Alibaba and Tencent

See important disclosures, including any required research certifications, beginning on page 58 China Internet Sector 14 August 2015

Contents

The Internet embraces entertainment ...... 5 Executive summary ...... 5 Online video and the multi-year entertainment boom ...... 8 The China entertainment sector: a brief history ...... 8 A glance at the online video market ...... 8 Content ecosystem in China: a primer ...... 11 A walk through the content supply chain in China ...... 11 The framework for content regulation in China ...... 12 Impact of “One Drama, Two Channels” on content costs ...... 14 Are China’s viewers losing interest in TV? ...... 15 TV-watching still popular, but online video momentum building ...... 15 Online content preference: an insider’s view ...... 15 Not all video content is created equal ...... 17 Audiences are content-driven, with a preference for home-grown shows ...... 18 How disruptive is online video to TV advertising? ...... 20 Online video ads: advertisers’ perspective ...... 20 Advertisers are embracing online video … ...... 21 … but there are challenges stopping them from spending more ...... 21 Youtube: a winding road of monetisation ...... 22 Online video ad revenue: unit economic analysis ...... 23 Online continues to take share; TV seeing no disruption for now ...... 24 Will online video subscriptions (ever) work in China? ...... 25 A tale of 2 countries: online video subscriptions in the US vs. China...... 25 Can Netflix replicate its success in China? ...... 26 Online video subscription with Chinese characteristics ...... 27 Content differentiation is key ...... 28 A golden age of content creation in China ...... 31 When we talk about IP, what exactly do we mean? ...... 31 The rising value of content owners ...... 31 The role of the Internet giants in the changing content ecosystem ...... 34 “BAT”: transforming into entertainment conglomerates ...... 36 Appendix: how interested is the post-90s generation in subscribing to video? ...... 38

Company Section Alibaba Group ...... 40 Tencent Holdings ...... 43 Baidu ...... 46 Youku Tudou ...... 49

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Information Technology / China 14 August 2015

an inflection point for the subscription model • Reiterating Buy (1) calls on Alibaba and Tencent

Content creators are seeing across all demographic groups will appreciating value. In order to take years to play out. differentiate themselves and attract organic traffic, the major online ■ What we recommend video players are entering the We reiterate our Buy (1) ratings on John Choi content creation business and Alibaba (BABA US, USD73.50) and (852) 2773 8730 starting to undertake in-house Tencent (700 HK, HKD134.90), as [email protected] production. Even though in-house we think both are well-positioned to production is still insufficient to benefit from the rising demand for Alex Liu meet viewer demand completely, we entertainment in China. We see (852) 2848 4976 expect to see greater investment in, synergies between Alibaba’s [email protected] and supply of, web-exclusive entertainment investment and its

content. Nonetheless, we believe in- core e-commerce & payment ■ What's new house content will remain a minority services. For Tencent, we see Monthly movie box office takings in traffic and revenue contributor for multiple layers of monetisation China reached a historical high online video platforms in the near potential from its content portfolio. (CNY5.5bn) in July 2015. Along with term. booming entertainment Finally, although we believe iQiyi consumption, online video has Ads will likely continue to be has a leading position in the online become the latest battlefield of the main revenue driver. We video sector, we are concerned that China’s Internet giants, as well- expect advertising to continue to be the aggressive investment of Baidu funded players spend heavily on the main revenue source for online (BIDU US, USD160.82) in O2O content in a bid to win market share. video platforms. Contrary to services will weigh on its near-term In this report, we delve into China’s common belief, we do not expect TV profitability. entertainment ecosystem and ads to face a sharp decline in ■ How we differ identify key trends and the potential revenue due to the TV networks’ winners in this dynamic segment. core position in the content supply We are more positive than the chain and solid coverage of many market on the potential value ■ What's the impact demographic groups. Meanwhile, we appreciation of content creators. believe online video ads may face a Internet giants transforming Key stock calls into entertainment challenge from a lack of premium ad inventory going forward. New Prev. conglomerates. We are optimistic Alibaba Group (BABA US) about the role of large Internet Subscriptions have yet to hit Rating Buy Buy companies in leading content Target 95.00 95.00 the mainstream. We believe it is innovation and monetisation. Given Upside  29.3% too early to call an inflection point their close proximity to users’ daily Tencent Holdings (700 HK) lives, Internet companies with good for online video subscriptions. In Rating Buy Buy capital bases are likely to drive users’ our blue-sky scenario, subscriptions Target 175.00 175.00 entertainment demand, and could will account for only 30% of total ad Upside  29.7% transform into entertainment revenue by 2020E. Our in-house Baidu (BIDU US) survey shows that the younger Rating Hold Hold conglomerates in the longer term. Target 175.00 200.00 generation is more willing to subscribe to online videos, yet we Upside  8.8% argue that such a behavioural shift Source: Daiwa forecasts.

See important disclosures, including any required research certifications, beginning on page 58 China Internet Sector 14 August 2015

Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg Alibaba Group BABA US 73.50 Buy Buy 95.00 95.00 0.0% 16.611 16.611 0.0% 22.040 22.040 0.0% Baidu BIDU US 160.82 Hold Hold 175.00 200.00 (12.5%) 34.286 35.210 (2.6%) 44.179 49.319 (10.4%) JD.com JD US 26.77 Outperform Outperform 38.00 38.00 0.0% (1.633) (1.633) n.a. 0.148 0.148 0.0% Tencent Holdings 700 HK 134.90 Buy Buy 175.00 175.00 0.0% 3.237 3.237 0.0% 4.175 4.175 0.0% Vipshop VIPS US 19.21 Buy Buy 30.00 30.00 0.0% 0.600 0.600 0.0% 0.901 0.901 0.0% Source: Daiwa forecasts

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Key question 2: how disruptive is online video to the TV ad market? We see online video continuing to eat into the time spent and ad spending share of the TV networks, yet we do not expect a sharp decline in revenue for the TV ad market in the short term, as TV remains at the centre of The Internet embraces content creation and covers a solid share of demographic groups. entertainment We also delved into the unit economy of online video ads for popular content. We found that: 1) online ads Executive summary are already priced at a similar level to premium TV ads, and 2) for the most popular content, advertising The principal problem in our society is that revenue can barely cover rising content prices. production falls short of the ever-growing material and cultural needs of the people. Key question 3: is the online video subscription model ready to take off? 我国社会的主要矛盾仍然是人民日益增长的物质 Despite rising interest in paying for video 文化需要同落后的社会生产之间的矛盾。 subscriptions, especially among the younger generation, we have not seen the inflection point for - Constitution of China Communist Party online video subscriptions yet. Under our blue-sky scenario analysis, subscriptions will only account for Online video platforms have grown in parallel to the 30% of total ad revenue by 2020E. booming entertainment market in China. From pioneers including Tudou and Youku, to later entrants We conducted proprietary research to gauge the such as Leshi and Tencent Video, the fast-changing younger generation’s stance toward online video industry landscape of the online video sector has made subscriptions (please see page 38 for more details). We it one of the most dynamic verticals within the China found that younger people (especially those born after Internet space. the 1990s) exhibit higher paying interest toward online video subscriptions. On the other hand, we expect it to In this report, we look at online video specialty players take years for this behavioural shift to spread to as well as the Internet giants standing behind them broader demographic groups. (Baidu, Alibaba and Tencent [BAT]), examine current monetisation models in the context of the booming Key question 4: will content prices drop? entertainment industry, and seek to answer the We believe prices for the most popular content (the following questions. top-20 TV series and reality shows) are unlikely to drop in the near term due to: 1) rigid demand from online Key question 1: what is the role of Internet video platforms, 2) a decreased content supply due to players in the booming entertainment market? the “one drama, two channels” policy (see page 14 for We expect large Internet players to leverage their details), 3) rising production costs as producers chase online video platforms and pivot into the content after popular celebrities and IP rights. creation business, starting from in-house production. Eventually, we believe Internet companies will Online video has not become the major revenue transform into media conglomerates that control contributor for BAT. As of 2Q15, iQiyi contributed only portfolios of high quality intellectual property (IP) in around 6% of Baidu’s revenue, with less than 8% the long term. revenue coming from the video business for Tencent. We do not expect online video ads to be a major Compared with US entertainment conglomerates revenue driver for BAT any time soon, but their which have integrated positioning across the investment in the entertainment sector should benefit entertainment supply chain, BAT would invest mainly them from the selling value/monetisation potential of in content creation (TV series/movie production) for content and IP in the longer term. now, in our view, as the segment is much more fragmented with a lower entry barrier. In terms of Alibaba (BABA US, USD73.50, Buy [1]) content distribution, we believe BAT is likely to form We believe Alibaba has great ambition in terms of the partnerships with state-backed TV stations to mitigate Chinese entertainment sector. In our view, Alibaba is regulatory risk. trying to extend user engagement from e-commerce

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transactions to the entertainment sector. By investing Shanghai Oriental Pearl Media Group or forming partnerships with leading entertainment (SOPMG 上海东方明珠新媒体集团) 600637 SH players, including Alibaba Pictures, Huayi Brothers Market cap: USD16.6bn and Wasu Media, we see Alibaba’s efforts to extend its SPOMG is a leading media conglomerate in China leadership into the entertainment sector and see whose business lines comprise content production, substantial monetisation potential ahead. cable network, online video and advertising, with a

focus on the Yangtze Delta area. SPOMG, the post- Tencent (700 HK, HKD134.90, Buy [1]) merger entity of BesTV and Oriental Pearl Group, is Tencent has stepped up content investment in its video China’s largest media group based on market cap. business, resulting in rapid traffic share gains in the past 2 years. We believe Tencent will continue to spend not Huayi Brothers (华谊兄弟) 300027 SZ just on video content, but also online literature and Market cap: USD7.7bn online music. We also see substantial synergies between Tencent’s content investment and its core gaming Huayi Brothers, founded by Wang Zhongjun and his business, as content investment adds another layer of brother, Wang Zhonglei, is a leading movie/TV series monetisation through in-house IP-based games. production house in China. Huayi Brothers maintains close relationships with well-known directors and Baidu (BIDU US, USD160.82, Hold [3]) actors/actresses, including Feng Xiaogang, Zhang Jizhong, Hark Tsui, and AngelaBaby. Both Tencent and Through iQiyi and PPS, we think Baidu is well- Alibaba have strategic investments in Huayi Brothers positioned in the Chinese online video sector. We see (each has around a 5% equity holding). strong content sourcing capability from iQiyi, and acknowledge its ongoing efforts to innovate in-house Enlight Media (光线传媒) 300251 SZ content genres. Compared to Alibaba and Tencent, Baidu has been relatively conservative in terms of its Market cap: USD6.6bn upstream content creation investment, but we think is Founded by Wang Changtian, Enlight Media is a likely to focus more on this front going forward. leading movie/TV series production house in China. Started as an entertainment news producer, Enlight Among our coverage, we have also identified several Media has grown and delivered a handful of popular key listed players (all China A-share listed) in China’s TV series/movies, including Life of Ms. Ma and Lost in entertainment industry as below. Thailand, over the past few years. Alibaba now has around an 8.8% equity holding in the company. Leshi (乐视) 300104 SZ Wasu Media (华数传媒) 000156 SZ Market cap: USD14.3bn Market cap: USD7.5bn Leshi is a leading online video platform in China. Led Wasu Media is the regional TV cable operator in the by founder Jia Yueting, Leshi launched a line of self- Hangzhou area and one of the 7 holders of a national brand TV sets in 2013 and has pioneered content-TV Internet TV Broadcasting Platform Licence. In April set bundle services since then. In 2015, Leshi launched 2014, Jack Ma and Shi Yuzhu acquired a 20% equity 3 self-brand smartphone models and plans to launch holding in Wasu Media via Yunxi Investment, an more consumer hardware products going forward. investment holding company.

 China and the US: comparison of major media and Internet companies (July 2015) Alibaba Tencent Baidu Walt Disney NewsCorp Viacom Times Warner Comcast

(BABA US) (700 HK) (BIDU US) (DIS US) (FOXA US) (VIA US) Brother (TWA US) (CMCSA US) Online Video Youku (20.7% Tencent Video iQiyi & PPS Hulu (JV) Hulu (JV) HBO Now Hulu (JV) equity holding) Movie/TV Alibaba Picture Huayi Brother (5% Aquamen Disney Picture 20th Century Fox Paramount Warner Brothers Universal Studios Huayi Brother equity holding) Entertainment (US Pixar Blue Sky Pictures New Line Cinema Enlight Media movie producer) Marvel Studio DC Studio Lucasfilm Games UCWeb & 9game Tencent Game Playdom Riot Game Club Penguin Cable Networks Wasu Media Partnership with Partnership with ESPN Sky MTV HBO NBC Partnership with Hebei Broadcasting Hubei Broadcasting DIS Channel Fox News BET CNN Bravo Gehua Media Group Group ABC Family Epix Comcast Internet Media 21CN Media Caixin Media ESPN.com SkyGo MTV.com HBO.com Xfinity QQ portal Disney Family IGN Theme Parks Disneyland Universal Studios Source: Daiwa - 6 - China Internet Sector 14 August 2015

 China: Internet and media sector comparable valuation (as of August 12th 2015) Ticker Short Name Market price Market cap PER PER P/S P/S PBR PBR EV/EBITDA EV/EBITDA ROE % (local curr) (USDm) FY1 FY2 FY1 FY2 FY1 FY2 FY1 FY2 FY1 China Internet 700 HK Equity TENCENT* 134.90 161,640 34.3 26.6 10.3 8.0 8.7 7.0 20.1 15.6 30.7 BIDU US Equity BAIDU INC-SP ADR* 160.82 56,336 31.3 24.3 5.3 4.1 5.8 4.7 25.5 17.9 20.5 NTES US Equity NETEASE INC-ADR 133.90 18,452 17.9 14.7 5.5 0.8 4.4 4.1 14.4 11.6 21.8 CTRP US Equity CTRIP.com-ADR 72.13 9,875 80.7 36.1 5.0 4.1 6.5 6.5 83.1 32.5 0.1 WB US Equity WEIBO CORP-ADR 13.25 2,738 59.7 23.2 5.3 4.2 1.9 n.a. 43.9 17.5 (15.8) SINA US Equity SINA CORP 39.07 2,293 68.7 26.9 2.6 2.3 1.1 n.a. 31.9 12.4 12.6 SFUN US Equity SOUFUN HOLDI-ADR 6.99 2,910 59.2 24.1 1.8 2.5 4.6 2.4 37.9 23.0 47.1 ATHM US Equity AUTOHOME INC-ADR 33.42 3,655 22.6 17.0 5.9 5.0 5.6 n.a. 16.4 12.2 26.2 BITA US Equity BITAUTO HOLD-ADR 28.99 1,826 28.2 15.3 2.9 1.4 1.1 n.a. 13.9 7.1 12.7 WUBA US Equity 58.COM-ADR 50.55 5,953 n.a. n.a. 8.7 6.6 8.3 n.a. n.a. n.a. (8.2) QUNR US Equity QUNAR CAYMAN-ADR 38.20 5,034 n.a. n.a. 8.1 5.6 n.a. n.a. n.a. n.a. n.a. YOKU US Equity YOUKU TUDOU INC 18.68 3,735 n.a. n.a. 3.3 2.7 1.7 6.7 n.a. n.a. (10.5) SOHU US Equity SOHU.COM INC 49.45 1,942 n.a. 57.8 0.9 0.8 1.6 1.1 10.0 5.7 (8.7) Average 44.7 26.6 5.0 3.7 4.3 4.6 29.7 15.6 10.7 China E-commerce BABA US Equity ALIBABA GRP-ADR* 73.50 180,884 29.7 22.4 11.7 8.9 4.9 3.8 22.1 15.1 21.9 JD US Equity JD.COM INC-ADR* 26.77 36,947 n.a. n.a. 1.2 0.9 6.9 6.7 n.a. n.a. n.a. VIPS US Equity VIPSHOP HOLDINGS* 19.21 11,108 30.4 20.3 1.5 0.9 12.1 7.7 21.4 10.4 56.3 JMEI US EQUITY JUMEI INTERNATIO 16.32 2,380 32.3 18.8 1.9 1.5 2.5 3.7 23.9 11.7 18.4 Average 30.8 20.5 4.1 3.1 6.6 5.5 22.5 12.4 32.2 China Media 002739 CH Equity WANDA CINEMA L-A 199.00 17,417 94.6 65.9 14.2 10.1 33.2 n.a. 59.7 44.6 n.a. 600637 CH Equity SHANGHAI ORIEN-A 42.52 16,576 39.4 31.1 6.0 4.6 10.4 n.a. 24.5 17.9 19.0 300104 CH Equity LESHI INTERNET-A 50.77 14,288 144.2 99.2 6.7 4.5 28.7 19.8 49.7 37.5 15.0 300027 CH Equity HUAYI BROTHERS-A 39.58 7,684 42.4 33.9 15.5 12.4 7.6 6.4 34.9 26.5 15.2 000156 CH Equity WASU MEDIA HOL-A 35.41 7,514 81.0 60.7 17.6 14.5 17.4 7.7 48.3 44.8 20.3 300251 CH Equity BEIJING ENLIGH-A 30.20 6,573 73.7 53.5 24.7 18.6 12.6 8.9 68.9 51.9 12.2 600037 CH Equity BEIJING GEHUA-A 30.79 5,244 41.6 32.1 13.0 11.5 5.1 5.0 27.4 21.8 10.0 300133 CH Equity ZHEJIANG HUACE-A 31.38 4,653 48.0 36.9 9.9 7.8 9.1 n.a. 38.1 28.4 15.3 Average 70.6 51.7 13.44 10.5 15.5 9.5 43.9 34.2 15.3 US Internet AAPL US Equity APPLE INC 115.15 657,182 12.6 11.8 2.7 2.7 5.2 5.1 6.2 6.0 41.1 GOOG US Equity GOOGLE INC-C 656.45 462,227 22.7 19.6 7.2 6.5 n.a. 3.7 13.2 11.3 14.0 FB US Equity FACEBOOK INC-A 93.43 265,529 45.3 34.3 13.2 11.4 6.7 6.5 23.1 17.1 9.4 PCLN US Equity PRICELINE GROUP 1,285.47 65,644 22.6 18.7 6.5 6.0 7.7 7.0 18.4 15.4 28.9 YHOO US Equity YAHOO! INC 35.93 32,469 52.6 52.1 8.2 7.8 1.0 1.0 28.2 28.3 30.0 TWTR US Equity TWITTER INC 28.54 19,877 87.0 46.0 7.2 6.1 4.5 4.7 32.1 20.3 (16.5) EXPE US Equity EXPEDIA INC 120.66 15,597 30.0 22.3 2.2 2.0 7.4 6.3 13.5 10.6 41.0 TRIP US Equity TRIPADVISOR INC 71.70 10,591 34.6 27.1 6.0 5.6 8.3 8.0 20.1 15.7 18.6 LNKD US Equity LINKEDIN CORP-A 188.82 24,625 83.5 52.6 7.3 6.4 5.9 6.3 33.7 23.0 (3.2) Average 43.4 31.6 6.7 6.1 5.8 5.4 21.0 16.4 18.2 US Media NFLX US Equity NETFLIX INC 123.73 51,140 354.5 261.6 6.9 5.9 25.9 26.2 106.5 91.3 10.6 IMAX US Equity IMAX CORP 35.22 2,438 31.3 26.9 6.8 6.3 5.7 5.2 16.1 14.1 13.0 CBS US Equity CBS CORP-B 50.05 24,318 14.6 12.0 1.7 1.7 4.1 4.4 10.0 9.0 37.1 TWX US Equity TIME WARNER INC 79.03 65,173 17.0 13.8 2.2 2.1 2.7 2.8 10.8 9.5 14.5 FOXA US Equity TWENTY-FIRST C-A 30.12 61,409 16.2 12.9 2.1 2.0 3.6 3.6 10.4 9.1 48.0 VIA US Equity VIACOM INC-A 46.55 18,336 8.4 7.5 1.3 1.3 6.4 5.7 7.7 7.0 50.4 DIS US Equity WALT DISNEY CO 107.52 180,584 21.3 19.2 3.3 3.2 3.7 3.8 12.3 11.4 18.0 CMCSA US Equity COMCAST CORP-A 59.64 148,213 18.1 16.1 2.0 1.9 2.8 2.8 7.9 7.5 16.7 Average 60.2 46.3 3.3 3.1 6.9 6.8 22.7 19.9 26.0 Source: Bloomberg, Daiwa; *based on Daiwa forecasts

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 China: national gross box office trend (1H10-1H15) (CNYbn) 25

15 10.8 Online video and the 6.4 10 7.1 4.1 4.9 multi-year 3.5 3.3 5.3 5 1.7 2.8 9.5 9.5 2.7 6.9 6.6 4.1 5.5 5.9 2.1 3.6 2.9 2.8 entertainment boom 0 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 Domestic Movies Imported Movies

The China entertainment sector: Source: SARFT a brief history

The entertainment industry in China is still A glance at the online video underdeveloped given its shorter period of market development compared to major developed countries. The entire market used to be tightly controlled by the Chinese audiences have quickly embraced online video state, under which the government planned and over the past few years. According to the China coordinated content creation and distribution. After Internet Network Information Center (CNNIC), there Deng Xiaoping’s reforms in 1978, the entertainment were over 433m online video users in China at the end industry started to see the presence of private capital, of 2014. Online entertainment is the second most though the market is still closely monitored by the popular activity online, accounting for 35% of the total government nowadays. online time spent in China, ranking second after 47% for social networking. The premier of Ke Wang (渴望) in 1990 (China’s first homegrown TV drama), Stories from the Editorial The monetisation model for online video platforms is Board (编辑部的故事) in 1991 (China’s first TV very straightforward. Advertising (mostly display- comedy), I Love My Family (我爱我家) in 1995 (the based) is the dominant revenue generator for the whole first Chinese TV sitcom) and the Fugitive in 1994 (the industry right now, contributing around 58% of total first imported movie released in China under the industry revenue as of 1Q15, according to iResearch. government’s box office revenue sharing scheme), and Meanwhile, we see new business models being carried The Dream Factory (甲方乙方) in 1997 (China’s first out by online video platforms including content sub- licensing, subscription, and co-operation of online commercial blockbuster movie) all mark the gradual games. However, none of the above new business opening up of China’s content creation market. models has yet become a major revenue contributor.

Over the past 2 decades, the overall entertainment According to iResearch, China’s online video industry has become one of the most competitive and advertising market was worth around CNY15.2bn in market-oriented sectors in China, with participation 2014, accounting for 9.7% of the total online from both state-backed players as well as private advertising market. iResearch expects China’s online capital. In 2014 alone, there were over 618 movies and video advertising market to expand at a CAGR of 37% over 15,000 episodes of TV series produced in China, from 2014 to 2018E, reaching CNY54.1bn by 2018E. In making China one of the largest content production our view, the ramp-up of mobile video ads, enhanced and consumption countries in the world. targeting mechanism and new ad formats will drive the

structural growth of the online video ad market.

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 China: online video ad market forecasts (2011-18E) According to eMarketer, the mobile video advertising (CNYbn) market in China was worth CNY2.5bn in 2014, and is 60 54.1 expected to grow at a CAGR of 73% from 2014-17E to 50 CNY13bn in 2017E. 42.7 40 32.2  China: mobile video ad market forecasts (2012-17E) 30 (CNYbn) 22.9 14 13.0 20 15.2 9.8 12 6.7 10 4.3 10 9.1

0 8 2011 2012 2013 2014 2015E 2016E 2017E 2018E 6 5.3 Source: iResearch 4 2.5 2 Mobile drives incremental time spent on 0.2 0.5 online video 0 2012 2013 2014 2015E 2016E 2017E Specifically, we see the broader adoption of mobile Internet as a structural growth driver for online video Source: eMarketer overall. According to eMarketer, 67.1% of Internet users in China choose mobile devices as the preferred Weak profitability industry-wide amid device for digital video content. We have also seen a aggressive content spending rapid increase of time spent on mobile devices over the The online video industry landscape is highly past 2 years. As the chart below shows, based on competitive with the 4 leading major video players all iResearch’s data, the daily average time spent on online claiming to have over 300m monthly active users video from mobile devices grew to 26.1 minutes in (MAUs). After Alibaba’s investment in Youku Tudou in November 2014 from 13.3 minutes in November 2013, 2014, there are no more stand-alone online video representing a 96.2% YoY growth. players in China, with the 4 leading platforms all backed by major Internet giants, namely Baidu (a  China: online video time spent between mobile and PC (2013- 14) controlling shareholder of iQiyi), Alibaba (a strategic investor in Youku Tudou), Tencent (Tencent Video as a (minutes) 25.6 26.1 wholly owned subsidiary) and Sohu (Sohu Video as a 22.2 22.4 21.9 20.7 wholly owned subsidiary). Well-funded video players have aggressively bid for content, leading to significant 13.3 content price inflation over the past 5 years, and 10.2 hurting profitability.

As the chart below shows, as the only listed online video player, Youku Tudou’s profitability has worsened Aug-13 Nov-13 Aug-14 Nov-14 at the operating level over the past 3 years despite Average time spent per user per day - PC revenue increasing 3-fold. The main cause of the Average time spent per user per day - Mobile lacklustre profitability is significantly higher content

Source: iResearch costs, which had risen almost 5-fold in 1Q15 from 1Q12.

We think mobile offers an attractive value proposition for online video users, as they can watch videos whenever they want. Also, further proliferation of 4G in China should help drive mobile video time spent in the next few years. According to MIIT, average monthly cellular data usage reached 321MB per user in 1H15, up 84% YoY; however, data usage in China is still far less than around 800MB in the US, 3GB in Korea and over 8GB in Taiwan. We see considerable potential for mobile video consumption, driven by increasing mobile data usage going forward.

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 Youku: historical quarterly revenue, content cost and operating income (1Q12-1Q15) (CNYm) 1,500

1,000

500

(500)

(1,000) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15

Net revenue Content cost Operating Loss

Source: Company

Although we are upbeat on the robust revenue growth trend, which validates our thesis on increasing video ad spend given the greater time spent on video, we are concerned about the consistent weak profitability as a result of surging content costs over the past 3 years. In later sections, we dive into the content ecosystem in China and analyse what is driving the growth of ads revenue and content spending, and how those factors may trend in the future.

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studios have dedicated teams that seek appealing ideas and later funding, and then assemble those ideas into draft scripts.

Draft scripts for TV shows and movies are required to be pre-approved by the Statte Administration of Radio, Content ecosystem in Film and Television (SARFT) before filming starts. Actual production starts once the producers receive China: a primer pre-approval. A TV series normally takes 3-6 months to produce (2-4 months for movies). A walk through the content supply chain in China

Similar to the US, content in China is produced based on either original scripts or adaptations of popular shows/fiction literature. Production houses and movie   China: media content creation ecosystem

Source: Daiwa

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Cinema chains and TV networks as well as online video In China, the production process for a TV series is platforms are the major content distribution channels completely different from that in the US. All shows are in China. Specifically, 40-50 satellite TV stations with required to submit a complete filmed copy of the entire national coverage have the highest viewer base. In show (ie, all episodes) for the SARFT’s final approval recent years, Hunan TV, Jiangsu TV and Zhejiang TV before broadcasting; the “shoot while you broadcast” have emerged as top-tier satellite TV stations in terms model is simply not viable in China given the of ratings, due mostly to their outstanding content regulatory constraints. The producers and investors of creation capability and larger advertiser base. the series bear a significant amount of the risk, as they have to invest in the first place and hope that they can Generally, TV stations have much stronger bargaining eventually sell the shows to TV stations for a profit. power over TV series producers and publishers, given their dominance in content distribution channels. However, the surging popularity of online videos in The framework for content recent years has provided content producers with a regulation in China new channel to reach audiences.

SARFT: an all-powerful regulator A major distinction in TV content distribution between China and the US is the concept of “cable”. In the US, The SARFT (国家新闻出版广电总局) is responsible for TV signals and broadband Internet services are usually regulating and supervising the entire television, film, transmitted via one hybrid cable network. In China, the radio, press and publication industries in China. Its TV cable network is completely isolated from the main task is to review content, whether online or broadband Internet network, and regulated by 2 offline, or in the format of video, audio or in paper different government agencies. Broadband services are form, to make sure it complies with domestic laws and usually operated by China Unicom or China Telecom, regulations. whereas the TV cable network is operated by local TV cable service agencies (usually state-backed entities). The SARFT sits at the centre of the content ecosystem in China. It grants movie/TV series production licences On top of that, in the US, TV production houses and distribution licences. Although online video produce one “pilot” episode of a new series for a TV players are mostly regulated by the Ministry of network’s senior management’s final approval as to Industrial & Information Technology (MIIT), all the whether to produce an entire season or not. The lucky content shown online is also subject to the SARFT’s few new shows that are selected are then broadcast via scrutiny. the TV network in the next year. Depending on the rating and audience feedback, networks and producers may decide to renew or terminate shows during broadcasting.

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 China: TV/film regulatory framework (July 2015)

Key Regulator - SARFT (国家新闻出版广电总局）

TV Series Publishing TV Station Review Permit (电视台映前审查) (电视剧发行许可) TV stations are TV series can only be TV Series/Film required to self-review Production Permit published after the Producer Operation TV series content (电视剧/电影备案及摄 publishing permit has Licence before broadcasting. 制许可) been obtained. (电视剧/电影经营许可) TV series/film Players engaging in TV producers have to series/film production apply for a shooting are required to obtain permit before shooting Film Final Review Film Publisher Permit the corresponding begins. Plot outlines (电影内容审查) (电影发行许可) licence. must be reviewed by the SARFT. Each film needs to be Film publishers are reviewed, and if required to obtain a approved, issued a licence from the publishing permit SARFT to conduct before being shown. business.

Source: SARFT, Daiwa

 China: recent policies from the SARFT on content creation and distribution (2010-15) Announcement Date Main message Reality shows should focus on ordinary people’s lives Notice on TV reality shows 22/07/2015 Producers should not overly rely on celebrities to attract viewership 关于加强真人秀节目管理的通知 Encourage more domestic Chinese culture related reality shows Notice on the appearance of TV/Radio hosts & guest hosts TV hosts and guest hosts should not have flaws in their personal life 23/06/2015 关于进一步加强广播电视主持人和嘉宾使用管理的通知 Producers should not invite controversial guest hosts Notice on healthcare-related TV programmes Ads are not allowed for such shows 14/10/2014 关于做好养生类节目制作播出工作的通知 Guest hosts for healthcare-related shows need to have medical qualifications Notice on online broadcasting of imported foreign TV shows 05/09/2014 Imported TV shows/movies for online broadcasting also need review by the SARFT 总局重申网上境外影视剧管理的有关规定 Notice on TV series broadcasting rules (“One Show, Two Channels”) 15/04/2014 Each TV series can only be co-broadcast concurrently on at most 2 satellite TV stations 总局对卫视综合频道黄金时段电视剧播出方式进行调整 Notice on web series, micro movies and other audio video related Online streaming players are responsible for reviewing content on their websites programmes broadcasting online regulation 19/03/2014 Content reviewing guidance should follow TV series content reviewing regulations 关于进一步完善网络剧，微电影等网络视听节目管理的通知 Commercials during the series broadcasting time regulation 12/10/2012 Limits the time for commercials during broadcasting 关于进一步加强广播电视广告播出管理的通知 TV series content regulation Detailed guidance for TV series content: superstition, religion, horror content are not allowed to 19/05/2010 电视剧内容管理规定 be broadcast Source: SARFT, Daiwa compiled

From time to time, the SARFT will issue notices to More recently, the SARFT announced requirements for guide the entire content production industry. As shown the approval of all imported TV series broadcast on in the table above, such notices cover a wide variety of online video platforms (“限外令”). Online video topics and details for TV series, TV shows and movies platforms need to submit the entire season of the production & broadcasting entities. For example, based imported series, and can only show it to the audience on our discussions with industry contacts, TV series after receiving approval. This policy directly led to the adapted from PC games are no longer allowed. Also, TV price of foreign TV series being slashed in 2H14. series that involve time-travel-to-the-past (穿越剧) or Chinese historical drama (宫斗剧) will not get pre- approval.

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Impact of “One Drama, Two For producers: mixed impact Currently, TV stations remain the biggest revenue Channels” on content costs source for TV series producers. The “One Drama, Two Channels” policy will limit the bidding for TV series Here we take a closer look at one of the most impactful and negatively impact selling prices. policies the SARFT has announced on TV series broadcasting, and provide our analysis on the On the other hand, many producers are turning to implications for the overall industry and specifically, online video platforms to make up for the drop in cost of content. prices, and online video players are willing to invest in hot content to attract traffic. For instance, according to The policy “One Drama, Two Channels (一剧两星)” was Ciwen Media (002343 SZ, not rated), 45% of the announced in April 2014, and stipulates that no more licencing revenue for the hot TV drama, The Journey of than 2 satellite TV channels can air the same drama Flower (花千骨), are contributed by online video series during evening primetime, and no more than 2 platforms. Therefore, we see a mixed impact on episodes of the same drama series during primetime. producers from the policy, with producers with deeper The primary purpose of this policy is to encourage TV industry networks and strong portfolios of content channels to show more genres of content instead of actually benefiting. every TV station chasing the most popular shows. After more than 6 months of implementation, the impact on For online video platforms: mixed impact industry players can be seen, as highlighted below. The “One Drama, Two Channels” highlights the value of online video platforms, in our view. As a result of For TV stations: positive for top-tier TV this policy, we believe TV series producers are trying to stations diversify their revenue sources by focusing more on Before “One Drama, Two Channels”, TV stations online video channels. On the other hand, we believe usually formed consortiums and bid together for online licencing costs for top content are likely to certain popular shows. After the new policy, smaller TV remain high. Online video platforms are still price- stations that lack the capital can no longer afford to pay takers when negotiating with content providers, in our for first-round broadcasting of popular shows. For top- view. tier TV stations (Hunan TV, Jiangsu TV, and Zhejiang TV), they can still afford the hottest shows and are less Top content costs would remain high impacted by the policy. Based on previous discussions, we believe for online video players, top content costs are unlikely to drop in We believe the policy has actually reinforced the the near term, as content providers are increasing polarisation among TV stations. Top-tier TV stations have online content licensing costs to make up for the price higher content acquisition budgets and can buy more drop from TV stations. Also, there is continuous popular shows, and therefore are becoming more popular competition among online players bidding for popular and gaining more ad revenue, leading to increasing content, and no one is willing to step back yet. content acquisition budgets. From the following table, we can see that in 1Q15, 7 of 12 top rated TV series broadcast From another perspective, the inflation of content during primetime were broadcast on the 3 top-tier prices over the past few years could also be attributable stations, Hunan TV, Jiangsu TV and Zhejiang TV. to the regulator’s approval requirement for a complete  China: top rated prime-time TV series broadcasted in 1Q15 series before broadcasting. As producers and Ranking Name Broadcasting channel Rating broadcasting channels lack ways to mitigate the 1 武媚娘传奇 Hunan TV 3.15% investment risk on individual TV series, they simply 2 锦绣缘华丽冒险 Hunan TV 2.37% choose to invest in shows with the hottest celebrities/ 3 活色生香 Hunan TV 2.16% 4 锋刃 CCTV-1 2.02% hottest directors/hottest stories, as those projects seem 5 好大一个家 CCTV-1 1.94% to yield lower risk than investing in original 6 妻子的谎言 Hunan TV 1.58% stories/new crews. Celebrity compensation in China 7 老农民 Shandong TV 1.48% has been surging, and will likely boost content costs 8 别让我看见 CCTV-1 1.44% further going forward. 9 千金女贼 Jiangsu TV 1.28% 10 老农民 Beijing TV 1.26% 11 武媚娘传奇 Zhejiang TV 1.20% 12 何以笙箫默 Jiangsu TV 1.17% Source: CSM Notes: Prime-time refers to 7:30-11:30pm session

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per adult in the US is 255 minutes in 2015 vs. 274 minutes in 2011, a 2% CAGR decrease over 4 years.

 US: average time spent per day on major media by adults (2011-15) CAGR 2011 2012 2013 2014 2015 (2011-2015) Are China’s viewers Digital 3:40 4:20 4:51 5:15 5:38 11.4% Desktop/laptop 0:48 1:35 2:16 2:34 2:51 37.2% losing interest in TV? Mobile (non voice) 2:33 2:27 2:19 2:22 2:22 -1.8% Other connected devices 0:18 0:18 0:17 0:19 0:25 7.8% TV 4:34 4:38 4:31 4:22 4:15 -1.8% Radio 1:34 1:32 1:30 1:28 1:27 -2.0% TV-watching still popular, but Print 0:44 0:38 0:32 0:26 0:21 -17.0% -Newspaper 0:26 0:22 0:18 0:14 0:11 -19.8% online video momentum building -Magazines 0:18 0:16 0:14 0:12 0:10 -13.5% Other 0:39 0:38 0:31 0:26 0:24 -11.7% Before digging into the online video advertising market, Total 11.11 11.46 11.55 11.57 12.04 1.9% we think a fundamental question needs to be addressed Source: eMarketer first: are Chinese audiences no longer interested in TV due to the proliferation of online video? Leveraging eMarketer’s insights, we believe that online and TV are not competing for audience’s media time What we found from looking at a recent survey carried spent in the manner of a zero-sum-game. The truth is that out by eMarketer could come as a surprise to many user time spent watching TV has remained flat despite the investors: despite rapidly increasing time spent on rapid rising of digital content consumption in China. online video, the average time spent on TV per day has remained flat over the past 5 years in China, according On the other hand, we do acknowledge that digital to eMarketer’s research in May 2015. In other words, content time spent exceeded time spent on TV in 2014. online video time spent is growing, but not at the As audiences continue to diversify the channels for expense of TV, at least for now. Based on CNNIC data, content consumption, we expect the challenge from over 70% of TV audiences surveyed identified online video platforms to TV’s dominance on media themselves as multi-screen video viewers. time spent to grow further in the next few years.

We conclude that audiences are simply watching more digital content on PC/mobile devices in addition to Online content preference: an watching TV. insider’s view

 China: average time spent per day on major media by adults In order to better understand audience behaviour and (2011-15) content preference online, we examined the transcripts CAGR 2011 2012 2013 2014 2015 (2011-2015) of the past 8 quarters of earnings conference call for 4 Digital 1:47 2:07 2:34 2:53 3:05 15.3% major online video players (Youku Tudou, iQiyi, Mobile (non voice) 0:46 1:06 1:31 1:50 2:01 1.3% Tencent Video and Sohu Video), and extracted selective -Smartphone 0:22 0:39 0:55 1:07 1:15 27.5% -Tablet 0:05 0:11 0:22 0:30 0:35 36.0% management quotes on the industry dynamics. -Feature phone 0:19 0:16 0:14 0:13 0:12 62.7% Desktop/laptop 1:01 1:01 1:03 1:04 1:04 -11.8% First, it came as no surprise to us that each player in TV 2:45 2:42 2:42 2:41 2:40 -0.8% the online video market was optimistic about the Radio 0:11 0:11 0:11 0:11 0:11 0.8% Print 0:15 0:14 0:120:11 0:11 -7.4% growth prospects (traffic, users, etc.), yet unanimously -Newspaper 0:13 0:12 0:110:10 0:10 -5.1% noted the fierce competition on content acquisition. -Magazines 0:02 0:01 0:010:01 0:01 -7.4% Total 4:58 5:14 5:395:57 6:08 5.4% Second, despite efforts to differentiate themselves by Source: eMarketer creating in-house content, most managements still see

licenced content (mostly domestic TV shows and reality We also looked at the shift in audience media shows) attracting the majority of the viewership on consumption patterns in the US over the past few years. online platforms. Similar to what happens in China, despite a notable increase in digital content time spent, the average time Finally, over the past 2 years, we have seen a clear spent by US audiences watching TV has not shown a increasing focus on in-house production or professionally substantial decline over the past few years. According to generated content (PGC) across the board. eMarketer, the average time spent per day watching TV

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  China: management comments on content during quarterly results conference calls (2Q13-1Q15) Company 1Q15 results 4Q14 results 3Q14 results 2Q14 results 1Q14 results 4Q13 results 3Q13 results 2Q13 results “2015 is a year of step up “We stepped up content and new “For 2H14, as well as for 2015, “With the strength in balance “Our strategy is to sign long- “In regard to content syndication, “The price of TV dramas stabilized “We take a balanced approach for investment in content across all business investment in 2H14…we we're increasing our investment sheet, our portfolio of content term, high quality, multi-season we have secured a solid at high levels since the beginning investing in content. We continue categories…we have also are confident that this is the right in content in all categories, syndication and content shows including sources of pipeline that covers most of the of 2014 as we reported. Actually, to have a reasonable share of Youku secured a solid pipeline of time to make these investments including syndicated content, in production will increase diverse content from Korea, Hong first-run domestic TV series in the current price is not making head content, whereas our low- syndicated content that covers for our long-term growth.” building up our UGC and PGC aggressively. Our target is to Kong, Taiwan, and the U.S. as 2014. We also continue to gross profit for anybody. cost original content and the user- most of the first run type ecosystem.” maintain 30% to 40% market opposed to host domestic single strengthen our overseas content However, we also saw recently generated content are generating domestic TV series and variety - Dele Liu, President share of all the high engaging season TV dramas.” portfolio.” significant price inflation affecting higher and higher portion of traffic shows in 2015.” - Dele Liu, President professional syndicated variety shows.” over the last few quarters.” content in China.” - Dele Liu, President - Dele Liu, President - Dele Liu, President - Dele Liu, President - Victor Koo, CEO - Dele Liu, President “We made some successful in- “We’re trying to make this “In terms of overall traffic “Actually the largest part of the “I think it’s really hard to tell “I think the main consumption of “(In-house content) is actually house production, like Diors Men, business model work although percentage, the majority (of our cost is really content …each of speciallly (on gross margin) as we video content in China is still still represent a small part – but it’s still - the in-house our competitors are really traffic) is still coming from the them (video platforms) has a large did having a bigger competitor the TV drama, TV series…that's small percentage of our overall production is still representiing trying basically competing on viewing of the domestic TV financial backing and still fighting with really tons of cash ready to ouur key focus, as demonstrated by content acquisition. And we will Sohu a very small percentage of our our spending; we compete on dramas and variety shows and for market share. Only when bid up content prices, so it’s very the last quarter's successful continue to both focus on – content portfolio, on content smart spending and also on the also our in-house produced people become sensible, then difficult to say you right now.” marketing of a few major TV continue to focus on domestic TV assemble.” business model conversion.” content.” the price of ccontent will level dramas, TV hits. We'll continue dramas and also American TV off.” - Carol Yu, CFO with that.” episodes and also some variety - Charles Zhang Chaoyang, CEO - Charles Zhang Chaoyang, CEO - Charles Zhang Chaoyang, CEO shows.” - Charles Zhang Chaoyang, CEO - Charles Zhang Chaoyang, CEO - Charles Zhang Chaoyang, CEO “Content cost is strategic asset “Fresh content is vital to the “Content cost is strategic asset for “Fresh content is very important “The video business is kind of hit- “iQiyi will continue to focus on “Video has a lot of users and the for iQiyi and you should expect success of the platform. And we iQiyi and you shoulld expect that for iQiyi…we are committed to and-miss. It's quite content-driven, licensed high-quality content video viewing time, or media time, iQiyi that overall content cost to step remain highly committed to and overall content cost to step having fresh content for iQiyi and at least in the past…so we do not and we will continue to support is very long and growing faster (Baidu) up.” supportive of iQiyi.” up…2015 will be more continued growth of our user base expect iQiyi to win by unique iQiyi to take advantage of online than the general Internet usage. increased emphasis on the self- and its market leadership content. We expect iQiyi to win video's huge long-term It's a very easy to move the TV

- Jennifer Li, CFO - Jennifer Li, CFO produced content … (we position.” by the strong quality of service, monetization prospects.” commercial content to the believe) high quality content brand recognition and user video platform. ” differentiates iQiyi's platform - Jennifer Li, CFO traffic we can drive to them.” - Robin Li, CEO versus others.” - Robin Li, CEO - Robin Li, CEO - Jennifer Li, CFO “We believe that the value of “Like our peers, we are also doing “And then with regard to video, the strong IP content is some experiments in turn with competitive landscape, we’re appreciating over time…we content where we actually play a assuming will be very intense this Tencent dramatically increased our video role in the production process or year. We are budgeting video content spending from 2013 to in the execution process…we content cost to approximately 2014. We're extremely happy with certainly intend to continue to double year-on-year because the results…so you should be aggressive in terms of we want to outspend the market expect us to continue investing purchasing content.” a little bit and increase our aggressively in video content.” market share. ” - James Mitchell, CSO - James Mitchell, Chief Strategy - James Mitchell, CSO Officer (CSO) Source: Companies, Bloomberg, Daiwa compiled - 16 - China Internet Sector 14 August 2015

 Sohu Video: online video view distribution (July 2015) Not all video content is created 160 140 equal 120 100 80 The 20:80 rule in play: most traffic 60 40 concentrates on premium content 20 To validate managements’ observations above, we 0 季季 2 further looked into each platform’s content viewership 剧场花千骨 30th- distribution. As shown below, we found that the 虎妈猫爸继承者们武林外传龙门镖局一仆二主 1st- 闪电侠第 1 viewership on each video platform is disproportionally 10th- 40th- 50th- 60th- 80th- 屌丝男士第爱情悠悠药草香 70th-

skewed to a handful of top content, which are usually 石敢当之雄峙天东 20th- domestic dramas and domestic reality shows. It strikes 90th- us that the viewership distribution seems to follow the 100th- Source: Company, Daiwa famous 20:80 rule, where a smaller number of top content attracts the majority of views and traffic. An intuitive explanation for such disproportional viewership distribution is that For example, on Sohu Video, one of the top-4 online video content is time-consuming in nature. For video platforms in China, the number of views for the most people, there are only a few leisure hours th st 10 most popular show is less than 15% of the 1 most available each day to enjoy watching videos. It would th popular show, and the 100 most popular show has be physically impossible for one individual to enjoy all st total views of less than 1% of the 1 most popular show. the on-air shows available online. We further argue that audiences who are multi-tasking along with watching videos (long videos specifically) would inevitably be distracted to a certain extent.

 iQiyi: online content popularity index (July 2015)  Youku: online content popularity index (July 2015) 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 战狼左耳 4 季季季季花千骨两生花古惑仔爱回家生死连左耳怒放盗墓笔记极限挑战爱情公寓变形金刚冰雪奇缘生化危机心理罪生死连熊出没两生花花千骨奔跑吧兄弟快乐大本营欢乐喜剧人偏偏喜欢你爸爸回来了暴走大事件我们相爱吧爱情保卫战金星脱口秀何以笙箫默侏罗纪世界爱的妇产科 2 速度与激情 7 极限挑战为她而战虎妈猫爸特警力量闪亮茗天海上孟府盗墓笔记你是我的姐妹爱情公寓 Running Man Running 我们结婚了偏偏喜欢你欢乐喜剧人快乐大本营我们相爱吧何以笙箫默金星脱口秀后海不是海屌丝男士第四季怒放之青春再见 1 奇葩说第你是我的姐妹 4 屌丝男士第 2 奔跑吧兄弟第 2 爸爸回来了第爱的妇产科第二季 Running man (Korean Ver.) (Korean man Running

 Tencent: online content popularity index (July 2015)  Sohu: online content popularity index (July 2015) 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 2 季季期 2 季 2 有料失孤花千骨两生花生死连季完整期花絮武林风生死连花千骨两生花 2 闪亮茗天海上孟府虎妈猫爸极限挑战非你莫属鲁豫有约特种部队无人驾驶闪亮茗天风云天地海上孟府天降雄师伴我同行 : 偏偏喜欢你金星脱口秀后海不是海欢乐喜剧人大鹏嘚吧嘚有种你爱我虎爸潜伏记欢乐喜剧人快乐大本营何以笙箫默何以笙箫默奔跑吧兄弟出轨的女人新女婿时代偏偏喜欢你中国好声音梦中国惊奇先生 A 全球电影侦察中国惊奇先生你是我的姐妹屌丝男士第 4 3 极限挑战第全球电影侦察抓住彩虹的男人送小宝作品集锦撒娇女人最好命我在路上最爱你奔跑吧兄弟第奔跑吧兄弟第二季爸爸回来了第二季爱不爱之怦然心动熊出没之雪岭熊风哆啦开心麻花精彩小品熊出没之雪岭熊风 3 极限挑战第 18 猛龙特警之天罗地网奔跑吧兄弟第 THE KELLY SHOW 第 Source: Company Note: popularity index is based on the no. of search queries within each video platform; the no. of search queries is indexed to ensure comparability across platforms.

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In our view, the above observations suggest that online Audiences are content-driven, video platforms are still in the very early stage of with a preference for home- development in terms of content creation, sourcing and differentiation. For video viewers in China, online grown shows video sites are simply an extended TV screen, and they are following content instead of The hottest content online is the digital platforms. This has led to fierce competition for form of TV content content acquisition among online video platforms, After analysing the most popular content on each especially for genres such as domestic dramas and online video platform, we make 2 main observations: reality shows, which seem to be the most appealing content genres for Chinese audiences right now. • The most popular online video content comprises the digital form of TV content As highlighted in the chart and table below, the vast majority of the hottest video content online comprises contents shown on TV. Given the overlap between content shown on online video sites and TV networks is very high right now, online-exclusive content has yet to gain the popularity of licenced content. • The most popular online content is available on all major online video platforms We also note that the most popular video content is normally non-exclusive to a single online video platform, but available across all major platforms. For example, the top Chinese drama, The Journey of Flower (花千骨), and top reality show, Running Man 2 (Chinese Version) (奔跑吧兄弟第二季), are available on all 4 top online video sites, including iQiyi, Youku, Tencent Video and Sohu Video.

 iQiyi: top content on the platform is mostly digital-form TV content (July 2015)

Source: Company, Daiwa

- 18 - China Internet Sector 14 August 2015

 China: content popularity ranking based on search query comparison (July 2015)

Sohu Video Tencent Video Youku iQiyi

Content Co-broadcasting Content Co-broadcasting Content Co-broadcasting Content Co-broadcasting Ranking Name Name Name Name genre network genre network genre network genre network Reality 中国好声音 1 Drama 花千骨 Hunan TV Zhejiang TV Drama 花千骨 Hunan TV Drama 花千骨 Hunan TV Show 第 4 季屌丝男士 Reality Running Reality 奔跑吧兄 2 Comedy Sohu Video Drama 花千骨 Hunan TV Youku Zhejiang TV 第 4 季 Show man Show 弟第 2 季偏偏喜欢 Zhejiang TV & Reality 奔跑吧兄 3 Drama Hunan TV Drama 两生花 Zhejiang TV Drama 盗墓笔记 iQiyi 你 Jiangsu TV Show 弟 Zhejiang TV & 你是我的 Shandong TV & Reality 爸爸回来 4 Drama 两生花 Drama 偏偏喜欢你 Hunan TV Drama Zhejiang TV Jiangsu TV 姐妹 Anhui TV Show 了第 2 季 Reality 奔跑吧兄 Zhejiang TV & 你是我的姐 Shandong TV & 屌丝男士 Zhejiang TV & 5 Drama Comedy Sohu Video Drama 两生花 Show 弟第二季 Jiangsu TV 妹 Anhui TV 第四季 Jiangsu TV Hunan TV & Reality Reality 快乐大本偏偏喜欢 6 Drama 生死连有料 Tencent Hunan TV Drama Hunan TV Sichuan TV Show Show 营你 Reality 金星脱口 Reality 奔跑吧兄弟 Reality 欢乐喜剧你是我的 Shandong TV & 7 Oriental TV Zhejiang TV Oriental TV Drama Show 秀 Show 第 2 季 Show 人姐妹 Anhui TV Reality 极限挑战第 3 Tianjin TV & 8 Drama 闪亮茗天 Shenzhen TV Oriental TV Drama 盗墓笔记 iQiyi Drama 虎妈猫爸 Show 期 Oriental TV 后海不是 Tianjin TV + Reality 极限挑战第 3 偏偏喜欢 9 Drama Oriental TV Drama Hunan TV Drama 熊出没 CCTV 海 Oriental TV Show 期未播花絮你抓住彩虹 Zhejiang TV & Reality Zhejiang TV & 屌丝男士 10 Drama 武林风 Henan TV Drama 两生花 Comedy Sohu Video 的男人 Oriental TV Show Jiangsu TV 第 4 季 Source: Companies, compiled by Daiwa Notes: Shows highlighted refers to online video in-house productions shows

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 China: Youku pre-roll video ads on smartphone (July 2015)

How disruptive is online video to TV advertising?

Online video ads: advertisers’ perspective

Currently, most online video ads are priced based on impressions. Impression-based ads are exactly what TV networks have been delivering to advertisers consistently over the past few decades. Given the significant content and advertiser-base overlap Source: Company, Daiwa between TV networks and online video platforms, most online video sites in China are simply extending the Based on our industry research, there are several traditional display TV ads offering to online, in the factors that advertisers value the most when deploying format of pre-roll ads, and sometimes in-stream ads. ad budgets to online video platforms: •  China: sample pre-roll and in-stream video ads (July 2015) Reach iQiyi Reach, defined as the percentage of an audience exposed to a certain marketing campaign over the total audience size, is perhaps the top metric video advertisers value right now. Given the primary purpose of video ads is still brand building, the more audience one ad reaches, the more successful the campaign is. • Measurement For advertisers, the ability to accurately measure and evaluate the efficacy of a marketing campaign is another key factor affecting their ad budget allocation. Advertisers are more likely to prefer marketing channels that can provide more timely Sohu Video measurement and sophisticated analytical tools. • Interaction Finally, many advertisers put significant emphasis on the level of interaction between the audience and the promotional campaign. Advertisers are all actively looking for ways to promote better campaign interaction to spur brand engagement among the audience.

Source: Company, Daiwa

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Based on our discussions with industry players, we Advertisers are embracing online believe better audience targeting is another compelling video … reason attracting advertisers to online video.

Online video enhances customer reach … but there are challenges Given the similar pricing model and content overlap between TV and online video platforms, advertisers stopping them from spending and agencies can easily extend existing marketing more campaigns from TV to online. Huge demand, yet not enough ad inventory On top of that, the younger generation tend to spend As we have argued in previous sections, we believe more time watching online videos vs. the older audiences in China are still mostly content-driven, generation, and are therefore easier to reach through especially for popular licensed content (domestic TV online video marketing campaigns, as the chart below series and reality shows) that are digital forms of TV shows. Therefore, for any advertisers focusing on such content. As a result, advertisers are specifically chasing a demographic group or seeking to expand their that popular content to place ads simply because those demographic coverage, online platforms have become a longer shows attract a broader viewer base than vital marketing channel to reach such segments of shorter-length videos. prospective users.

 China: TV vs. online video ads reach comparison (Dec 2014) The skewed viewership toward a small number of premium content has led to divergent utilisation of ads (age) inventory. Advertisers are aggressively bidding for ads 50~60 inventory of premium content; few are interested in 45~49 shorter and long-tail UGC videos, mainly due to their 40~44 lack of reach (only a handful of audiences watch those 35~39 long-tail videos vs. millions of viewers for premium 30~34 content). The unbalanced advertiser interest in different genres of videos may limit the monetisation 25~29 capability of video platforms, in our view. 20~24 14~19 Programmatic-buying still too early to call Overall Some believe the proliferation of programmatic-buying 0% 20% 40% 60% 80% 100% purchases of online video ads could help solve the TV Ads Monthly Reach % Online Video Ads Monthly Reach % under-utilisation issues once and for all. We disagree.

Source: CSM In our view, programmatic-buying ads, the form of Online video offers better targeting digital ads that usually involve real-time ads placement automatically executed by pre-set computer Another factor contributing to advertisers pouring programmes (without manual direction), are still at the capital into the online video ads market is related to the very early stage in China, and it would require years of inherent measurement flaw of the traditional TV ads trial-and-error before achieving broader acceptance by market. The TV industry has been working to improve advertisers. Although some advertisers are already the accuracy of customer targeting over the past few utilising the large data points gathered from online decades. Until now, the usual practice within the TV video platforms to refine their marketing campaigns, ads industry is still the survey-based measurement there is still a big gap between “using data to support system that focuses on gross rating point (GRP). marketing staff making better campaign decisions” and “relying solely on programmes to execute ad placement On the contrary, users on online video platforms can be transactions”. traced and identified immediately, and therefore it would be theoretically possible to deliver customized We think it is still technically challenging for online ads to each viewer, depending on his/her previous video platforms to deliver true individualised ads based browsing history. on both the context of the video content and the browsing history of viewers. The bigger challenge is, unless online video platforms change their pricing mechanism from display-based to performance-based

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(ie, charge by click instead of by impression), the lack of reach issue will remain unsolved, and few Youtube: a winding road of advertisers would be interested in long-tail video monetisation properties. As the earliest and the largest online video sharing TV still at the centre of the content supply website, Youtube has singlehandedly created and chain shaped the global online video industry. After the As detailed on page 12, TV stations have been the major USD1.5bn acquisition in 2005, this wholly-owned content creation and delivery channels for Chinese subsidiary of Google has grown into the world’s largest audiences over the past 30 years. In our view, such a and most dominant online video community, with over dominant position is unlikely to change, at least in the 1bn active users as of 2Q15. next few years. On the other hand, the vibrancy of Youtube’s First, TV provides much more than just dramas and ecosystem has yet to translate into the equivalent reality shows, but also news and sports. The diversity of monetisation capability over the past few years. programmes remains appealing to certain demographic Without any public disclosure, it is estimated that groups. The reach of TV ads is significantly higher than Youtube generated around USD3bn and USD4bn that of online video ads in the 35-60 age group, based on revenue for Google in 2013 and 2014, respectively, and CVSC-Sofres Media (CSM). Even the younger generation roughly broke even, according to the Wall Street are not abandoning TV completely, as the reach of TV Journal citing a person with knowledge of the figure. ads for the 20-24 age group is still over 75%. Contributing to only 6% of Google’s 2014 total revenue, Youtube’s financial performance came in lower than  China: major media user penetration (2011-15) many had anticipated. 2011 2012 2013 2014 2015E TV viewers 93.5% 93.8% 94.2% 94.5% 94.8% Key strength: new ad formats Desktop Internet users 37.5% 40.7% 43.4% 44.8% 46.0% Smartphone users 16.6% 27.1% 34.5% 40.0% 43.1% The ads-based monetisation model of YouTube is fairly Feature phone users 51.2% 47.8% 45.8% 43.3% 42.0% straightforward. Video pre-roll ads, video in-stream Print readers 34.0% 33.0% 30.0% 28.0% 26.5% ads and banner ads are the major ad formats for -Magazine readers 12.1% 11.4% 10.8% 10.3% 10.0% Youtube. Advertisers pay Youtube based on -Newspaper readers 33.0% 32.0% 29.0% 27.0% 25.5% impressions (or effective impressions for TrueView ads, Tablet users 6.3% 9.1% 16.3% 19.7% 22.3% as detailed below). Youtube then shares its revenue Radio listeners 16.7% 17.0% 17.5% 17.7% 17.8% Source: eMarketer with channel owners/content providers, with Youtube normally taking a 45% share. We believe that, from a regulator’s perspective, TV is THE most important media channel given its distinct Notably, Youtube rolled out its new video ads format, features on information delivery – TV feeds audiences TrueView, in 2010. The distinctive “skippable” feature information PASSIVELY vs. audiences seeking of TrueView ads has significantly improved viewer information ACTIVELY online. TV remains the most experience and advertiser satisfaction. Viewers no penetrated media distribution channel in China, longer need to watch ads they have little interest in, covering over 95% of the population in the country. In and advertisers only need to pay for impressions shown our view, regulators could tolerate the parallel to highly engaged viewer groups. development of online video platform, but any sign of “disintermediation” of TV in China would immediately  Youtube: screenshot of TrueView ads (July 2015) alert regulators.

Video format still the luxury of large-brand advertisers Finally, we believe video ads have yet to gain the attraction of SME advertisers, due mainly to their relatively high cost of production. The cost required to produce a high quality video ad remains high. Amid capital constraints on marketing expense, most SME advertisers still find search engines to be a more targeted and controllable vehicle to place ads, instead of online video sites, in our view. Source: Google

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Key strength: unique demographic uploading websites (eg, Youtube), are growing rapidly coverage in terms of viewership. As users spend the majority of time-spent now on social networks, their consumption In addition to a more cost-effective ad format, Youtube of video content within social networks has increased. retains high engagement among younger generation Mobile is also amplifying this trend. Snapchat is users. According to the company, YouTube attracts essentially a mobile social platform that creates more viewers aged 18-49 than any other cable network thousands of live videos every minute. in the US. Given its unique demographic coverage,

Youtube has become a vital channel to reach young Leading social networks are also exploring ways to viewers for marketing purposes. capitalise on this trend. Facebook recently agreed with

selected channels, such as Fox & Friends, to test a Key challenge: lack of premium content video ad revenue-sharing scheme. Although we still see In our view, the lack of premium content on Youtube is Youtube as a content creator’s first choice platform, we the biggest factor holding back incremental ad budget fear that Youtube’s online video gateway position is at allocation to the platform. Due to the cable networks’ risk, and that such a trend would negatively impact its tight control over premium content (TV series, reality long-term monetisation outlook. shows, movies, etc.), Youtube’s content genre mix is significantly skewed toward UGC videos. As we argued before, UGC genres mostly target a specific niche Online video ad revenue: unit viewer base, and are mostly long-tail in terms of viewer economic analysis coverage. That is to say, the total number of viewers on Youtube may be quite large, yet each video may only attract a considerable small scale of viewers. The long- Online video ads don’t come cheap tail viewer distribution on Youtube vs. cable/ We looked into the unit economy for one single episode broadcasting networks creates a reach problem for of a popular TV series broadcast online, as shown advertisers, and therefore could limit their interest in below. For one episode of a popular TV series, under spending. our base-case scenario, we assume 15m online video views throughout the broadcasting period, and on Key challenge: the rise of social video average 4 pre-roll ads (30s each) for each view and an An imminent threat for Youtube is the proliferation of average cost per thousand views (CPM) price of social video. Social video, broadly referring to videos CNY40. played on social networks (eg, Facebook) instead of

 China: unit economy for one episode of licensed popular TV series (August 2015) Assumptions Notes Scenarios Bear Case Base Case Bull Case Our base-case assumptions are based on average views for popular series including The Total no. of views per episode (m) 10 15 20 Journey of Flower and My Sunshine. Multiply: Currently all major video platforms attach at least around 90-120s pre-roll ads. Our base- Average no. of ads impressions per view per episode 3 4 6 case scenario assumes 4 pre-roll ads of 30s apiece. Equals: Total No. of ads impression per episode (m) 30 60 120 Multiply: Our base-case CPM assumption is based on the current industry average price for a 30s pre-roll ad. The CPM could be higher if advertisers have extra requirements on ad Cost Per Thousand Views (CPM) (CNY) 30 40 60 placement (to appear first or be attached to specific shows), or are targeting audience in specific geographical regions (tier 1 cities vs. tier 2&3 cities). Equals: Total gross ads revenue per episode (CNYm) 0.9 2.4 7.2 Before tax

Ads cost per 15s (CNY) 150,000 300,000 600,000 Based on ad revenue forecasts above Ads cost per 15s - Hunan TV Prime Time (CNY) 150,000-350,000 Base price for Happy Family (快乐大本营) is now 350,000 per 15s. Ads cost per 15s - Jiangsu TV Prime Time (CNY) 200,000-350,000 Base price for If You Are The One (非诚勿扰) is now 300,000 per 15s. Ads cost per 15s - Zhejiang TV Prime Time (CNY) 180,000-300,000 Base price for Voice of China (中国好声音) has exceeded 400,000 per 15s.

The Journey of Flower licensing cost for iQiyi is around CNY2m per episode, based on the Content acquisition cost per episode (CNYm) 2.0-3.0 disclosure of Ciwen Media Source: Daiwa estimates, Hunan TV, Jiangsu TV, Zhejiang TV

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We found that, under our base case, total ad revenue The main reasons behind our relatively constructive for one single episode of a popular series is barely view toward the TV ad market are: enough to cover the content acquisition cost alone, not • Over the past few years, the time viewers have spent to mention the spending on bandwidth and marketing watching TV has remained flat, despite the rising as well as daily operation. The mounting content cost time spent on online video platforms. has become the biggest reason behind the poor profitability of online video platforms, in our view. The • The content overlap between TV and online more hot content they acquire, the more losses they are platforms is high, and consumers actually prefer likely to incur. digital forms of TV content.

• TV is still the major content generator in China. Based on our analysis, it is also worth noting that online ads are no longer a “cheaper” substitute for TV • Online video platforms face challenges from a lack of ads. Under our base-case scenario, the 15s pre-roll ads inventory and targeting enhancement. for one popular TV series will cost around CNY300k. • Such a price level is already in line, or sometimes Online video ads for popular content are no longer higher, than the price of a prime time ad on the top-3 price-competitive compared to TV. satellite TV channels. We acknowledge that the price premium could be due to advertisers’ wiliness to chase after the younger demographic group; however we see insufficient evidence to support the long-existing “spending on video ads just because it is cheap” thesis at this point.

Online continues to take share; TV seeing no disruption for now

To conclude, we believe the time spent on online video platforms will continue to rise going forward, driving ad revenue growth. For TV, we expect overall time spent to decrease YoY, yet a sharp drop of time spent as well as ad dollars look unlikely in the short term.

 China: share of average time spent per day with major media by adults (2011-15E) 2011 2012 2013 2014 2015E Digital 35.8% 40.5% 45.4% 48.5% 50.4% Mobile (non-voice) 15.4% 21.0% 26.9% 30.7% 32.9% -Smartphone 7.3% 12.5% 16.3% 18.8% 20.3% -Tablet 1.7% 3.4% 6.5% 8.4% 9.5% -Feature phone 6.4% 5.1% 4.1% 3.5% 3.1% Desktop/laptop 20.4% 19.4% 18.6% 17.8% 17.4% TV 55.5% 51.7% 47.6% 45.1% 43.6% Radio 3.7% 3.6% 3.4% 3.2% 3.1% Print 4.9% 4.3% 3.6% 3.2% 2.9% -Newspaper 4.4% 3.9% 3.2% 2.8% 2.6% -Magazines 0.5% 0.5% 0.4% 0.4% 0.3% Source: eMarketer

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Subscriptions have to yet to gain popularity in China In China, online video subscriptions are more akin to the premium membership programmes on offer in the US and elsewhere. Right now the subscription Will online video packages provided by the major online video players in China tout ad skipping as their major benefit, rather subscriptions (ever) than access to certain content. This approach is similar to that of online music services such as Pandora and work in China? Spotify, where users can opt for a free service but have to put up with regular interruptions from ads or pay a monthly fee for an ad-free experience. A tale of 2 countries: online video Given the ad-centric monetisation model of the China subscriptions in the US vs. China online video players, most of the popular genres, including domestic TV series, domestic reality shows, Netflix leads the way in online video and imported series are available to viewers free of subscriptions in the US charge (but with ads). We attribute the online video Over the past few years, subscription video-on-demand providers’ decision to monetise their services through (SVOD) has grown in popularity among Internet users ads rather than subscriptions to the following factors: globally. Pioneered by Netflix, the traditional US 1) while Internet users in China are increasingly willing networks (eg, Hulu, a joint venture of Fox, Disney and to pay for content, this is from a low base, 2) anti- NBC Universal), cable networks (eg, HBO Now from piracy enforcement measures are spotty, and 3) HBO), and even online retailers (eg, Amazon Prime payment channels, though improving, are not yet Video) have all rushed into this business amid booming hassle-free. consumer demand. As a result, the online video subscription business has In the US, the online video subscription business is yet to hit the mainstream as a way of monetising the very similar to the traditional cable business. Users vast amounts of video content on the web. We estimate typically pay a fixed monthly subscription fee (after a that iQiyi, which we believe has the largest video short free trial period) to access unlimited video subscriber base in China, has only 7m total active content across multiple devices. The majority of these subscribers out of a total base of 500m MAU. subscription services are provided without ads, with the exception of Hulu (users can pay more for an ad-  China: online video market revenue breakdown (2Q13-1Q15) free package). This “all you can eat” approach has been 100% very popular with users while also encouraging them to 3.8% 5.5% 80% 5.1% 5.4% 8.3% 8.6% stick to a single platform. 3.7% 4.7% 60%  Netflix: subscriber trend (3Q11-1Q15) 40% 75.5% 74.2% 68.7% 68.4% (million) 62.2% 58.7% 61.1% 58.2% 70 20% 59.6 60 0% 50 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 40 Advertising revenue Sub-licensing revenue Value-added service revenue Other 30 21.5

20 Source: iResearch 10 0 3Q114Q111Q122Q123Q124Q121Q132Q133Q134Q131Q142Q143Q144Q141Q15 Domestic streaming International streaming

Source: Company, Daiwa

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 Netflix: management quotes on potential China expansion Can Netflix replicate its success in from recent results calls (4Q14-2Q15) Time Quotes China? 2Q15 “I would say China continues to be sort of its own entity in terms of the result challenges and the particular characteristics of the market. We're taking There is no question that Netflix is the leader in the our time and being deliberate in finding a path and the right model to work. We hope to be able to launch the service there next year; and we'll continue to treat SVOD market globally. In the US, the company it sort of as its own territory.” successfully transformed itself from a DVD rental - David B. Wells, Chief Financial Officer company into a major disruptor of the cable industry. The rise of Netflix has eaten into the number of cable “We hope to open the entire rest of the world in 2016. So China, again, we still have some things to figure out, so I suppose that's possible.” subscribers market-wide, and the debut of the service - Reed Hastings, Chairman, President & Chief Executive Officer in new geographic markets (eg, the UK, Germany, 1Q15 “But it's not a reflection of whether we want to or what we are willing to do in Australia, and Japan) opens up a far bigger addressable result China. We are anxious and open to all forms of doing business in China.” market for the company. - Ted Sarandos, Chief Content Officer, Vice President of Content 4Q14 “So we need to get a licence (in China) that’s not the 100% clear that we’ll result be able to do that. So, we’re figuring that out. And what we said is that if we go Management retain s a prudent outlook on it will be a modest investment because we won’t have that much content. China expansion We’re going to be very cautious and feel our way along to that process if we’re able to get that licence.” Given Netflix’s aggressive international expansion - Reed Hastings, Chairman, President & Chief Executive Officer strategy, China, home to more than 300m households, Source: Bloomberg seems too big to ignore. Management’s recent comments on the China market indicate the company Regulations remain the biggest hurdle is indeed looking at ways to conduct its business there, Leaving aside the competitive landscape and but some challenges are holding it back. consumers’ acceptance of a monthly-subscription business model, we think Netflix’s potential China venture faces significant regulatory uncertainties. As we have mentioned, online video websites must register with the MIIT for an ICP licence and are also subject to regulation from the SARFT on content and broadcasting. Hence, Netflix’s content library would be subject to the SARFT’s review before being made available to viewers in China.

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 China: Internet TV regulation framework (July 2015)

Source: SARFT, Daiwa

There are also potential regulatory hurdles for Netflix’s • Netflix, as well as other doomestic online video IPTV service, ie, delivering the Netflix service to TVs players planning to conduct IPTV business, may sign through an Internet connection. As shown in the chart operating contracts with IPTV Broadcasting entities. above, such services are not permitted under the However, the SARFT has publicly expressed its existing regulatory framework in China: concern about such an approach. • IPTV business, as an extension of existing TV broadcasting, is regulated closely by the SARFT. Given the tight regulatory framework, as well as the • Companies seeking to offer IPTV broadcasting challenges of sourcing local content, we think Netflix services must first obtain IPTV Broadcasting would prefer to work with existing domestic online Licences (互联网电视集成播控牌照). video players to expand its service coverage to China, most likely in 2016 or later. Nonetheless, Netflix has • The SARFT has so far issued 7 such licences. In July licensed out some of its own productions to China 2014, the SARFT announced it would not grant any online video platforms (eg, House of Cards is licensed new IPTV Broadcasting Licences going forward. exclusively to Sohu Video), and we think this approach • All 7 entities holding IPTV licences are TV will be the main way for Nettflix to raise its profile in stations/corpporates affiliated with the SARFT. China in the near term. • The SARFT also issues IPTV Content Licences (互联网电视内容服务牌照) to content providers. Licencce holders are not permitted to conduct broadcasting business; rather, they can serve only as content suppliers. • The SARFT has issued 14 such licences to date. Applications are open only to local TV stations or local affiliates of the SARFT.

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subscribers pay CNY15 per month or CNY150 per Online video subscription with annum — more than the price of most online video Chinese characteristics subscription packages. We believe the popularity of such services highlights the depth of consumer demand. Over the past few years, we have seen industry dynamics in China starting to favour the online video In the past 2 years, the China government has stepped subscription business, as well as a growing interest up the enforcement of anti-piracy and intellectual among Internet users in paying for video content. property infringement measures. For example, one of Viewers are increasingly willing to pay the most popular video-sharing websites, Qvod (快播), was forced to close and the founder of the platform has In our view, China Internet users are more willing than been charged with copyright infringement. ever to pay for services.

James Mitchell, Chief Strategy Officer of Tencent, has Aside from rising disposable income levels, we believe said: “We see some signs that the attitudes [in China] that a major reason for this emerging trend is that toward piracy are changing quite quickly and that's payment systems in the country have advanced rapidly, both at a regulatory level and also a consumer level”. particularly those for mobile payments. In our view, the availability of widely accepted online payment In our view, as long as the regulators continue to enforce services (eg, Alipay by Alibaba and Tenpay by Tencent) anti-piracy measures, users in China will ultimately has made it much easier for consumers to complete gravitate to the legitimate online video platforms. online transactions.

Based on our on-the-ground survey (refer to the Ad loads are increasing Appendix for more details), Internet users in China From even a cursory inspection of online video born in and around 1990 are more open to paying for services, it is clear that video commercials are online video content than their post-1980s becoming longer and more frequent. We note that pre- predecessors. We believe that this demographic shift in roll ads for popular content on major online video behaviour heralds the start of a multi-decade-spanning platforms now run for 150-180 seconds, vs. 30-60 adoption of the online subscription business model in seconds just a few years ago. In-stream commercials China. are now more frequent, too. This cumulative increase in ad loads is likely to compel some audience members  China: survey on willingness to pay for online video to pay for a subscription package in order to skip the subscription across different age group (July 2015) ads altogether. Question: have you ever paid for online video packages? Content differentiation is key 50% 41% What can we learn from Amazon Prime? 36% 31% Ultimately, the market appeal of subscription packages of any kind hinges on whether the incremental charge for such services justifies their incremental utility. The subscriber benefits currently revolve around blocking ads, which we believe may not be a big enough draw for consumers (for the simple reason that viewers can 1980~1985 1986~1988 1989~1991 1992~1996 ignore the ads or open multiple windows on their (% of respondents who answered yes, devices at the same time). categorised according to their year of birth) However, we think the success of Amazon Prime may Source: Daiwa serve as an example of how to promote subscription

packages in China. The US retailer’s Prime service is a Also, the rapid rise of services offering pirated content membership programme for which users are required underlines, in a roundabout way, our point that to pay an annual fee of USD99. In return, members are consumers are prepared to pay for content. For example, eligible for free 2-day shipping of real-world items, plus 迅雷看看 XunLei Kankan ( ), a peer-to-peer video 1 free e-book rental per month and full access to streaming service that some copyright advocates believe Amazon’s streaming movie, TV series, and music gives users access to unlicensed content, had nearly 5m libraries. paying subscribers as of December 2014. Xunlei

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As we see it, the inclusion of e-book and streaming  iQiyi: promotion of subscription package (July 2015) services in the Prime package hits the spot for consumers and potentially serves as a big draw for non- members. In other words, services along the lines of Prime should have an edge in terms of customer stickiness, because users feel compelled to fully exploit the membership benefits.

It is important to state that we do not expect China to see the emergence of Amazon Prime-like services, ie, those mixing the delivery of physical items with the availability of online content (some produced in- house), because: 1) delivery speeds for physical goods are generally faster in China than in the US, and 2) the upfront investment in digital content would be too substantial.

Rather, we believe the takeaway from the success of Amazon Prime in the US for the China online video players is that they must have a rich and diverse content offering in order to sustain a successful Source: Company, Daiwa subscription model.

As for online video subscription in China, we think the Blue-sky scenario: video subscription still main reason subscriber numbers are modest is that the makes up only 30% of ad revenue in 2020E membership benefits are simply not attractive enough. Our back-of-the-envelope calculations suggest that, As proven by HBO in the 1980s and now Netflix in the even under our blue-sky scenario, video subscription 2010s, offering unique and compelling content is a key will account for only 30% of total video ad revenue in selling point for would-be subscribers. China by 2020, even with the rapid adoption of video subscription services. Hence, we believe that In recent months, iQiyi has tried to distinguish its advertising will remain the major monetisation subscription benefits from those of similar services by method for online video platforms in China in adding exclusive access to its popular in-house- the next 3 years. produced show, The Lost Tomb (盗墓笔记). Subscribers gain immediate access to the whole season of The Lost Tomb, whereas non-subscribers have to wait a week for each new episode to be made available. The strategy looks to have had the desired effect, with the company recording over 2.6m subscription purchase requests within 5 minutes of launching the show online.

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 China: our blue-sky scenario for the video subscription market (2020E) Blue-sky-scenario in 2020E Assumption Notes Currently there are 500-600m online video viewers in China, out of a total Internet user base Number of online video users in China (m) 700 of 650m. Multiply: We believe a 10% paying ratio is an aggressive assumption. In recent years, very few major Internet services in China have realised paying ratios that high (eg, the paying ratio for Paying ratio % 10% games tends to be less than 5%). In the US, Netflix has 40m subscribers, which translates to a paying ratio of around 20% given there are 200m digital content/video viewers. We think it is highly unlikely that China will see paying ratios of 20% within the next 5 years. Multiply: Number of subscriptions per paying user 1.5 We expect each user to subscribe to more than 1 video package. Multiply: We expect the ASP of subscription packages to rise modestly from current levels of around ASP of subscription package per annum (CNY) 200 CNY120-150 pa. Equals: Total video subscription revenue (CNYbn) 21.0

Total online video ad revenue in 2015E (CNYbn) 22.9 Based on iResearch estimates. 25 We expect online video to continue outperforming the overall online ad market in the next 5 Assumption: 2015-20E 5-year CAGR (%) years. We see our forecast as prudent. Total online video ad revenue in 2020E (CNYbn) 69.9 Subscription revenue as % of video ads revenue 30% Source: Daiwa, iResearch, Company

 China: subscription plans for major online video platforms (July 2015) iQiyi Youku Tencent Video Sohu Video Leshi Price of 12-month 198 169 150 49 198 subscription (CNY) Price of 1-month 19.8 20 20 5 24 subscription (CNY) No. of subscribers (our estimates as of 7m 3-4m 3-4m 1.5-2.5m 3-4m July 2015) - Exclusive access to full - Exclusive access to a basket season of popular in-house- of HBO series/mini-movies produced show “The Lost Tomb - Free downloads of The Voice - Free access to selected films - Free access to selected films (盗墓笔记)” of China music via QQ Music - Free access to selected films - No ads - No ads (except for US series) Subscriber - Free access to selected films - Exclusive HD broadcasts of - No ads (except for US series) - Faster network speeds - Faster network speeds privileges - No ads The Voice of China - Faster network speeds - 50% discount on selected on- - Free access to selected sport - Free games and live shows - No ads - Exclusive customer support demand videos programmes, including NFL - Free educational programmes - Faster network speed - 7 days of free music - Free virtual gifts for online live downloads from Baidu Music shows Source: Company, Daiwa

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The rising value of content owners

IP monetisation: online fiction A golden age of content In an age when new media channels are disrupting the traditional media ecosystem, we expect the value of creation in China content owners, ie, those who control popular IPs, to appreciate over time. Online fiction is the most common form of IP for follow-up adaptations in China. When we talk about IP, what According to CNNIC, there are over 280m readers of exactly do we mean? online fiction in China as of 1H15. The country’s online fiction market, which dates back around 15 years, is currently comprised of several large players, including To recap, we believe online video platforms will Tencent and Baidu. continue gaining ground, both in terms of time spent and advertising revenue, at the expense of TV. At the Specifically, Tencent acquired Shanda’s online same time, we do not foresee a sharp decline in TV literature business in 2014 and then merged it with its advertising revenue in the next 2-3 years, given TV own reading business to form China Reading Group (阅 occupies a core position in the fields of content creation and distribution. Also, while we detect a growing 文集团). China Reading Group, which Analysys interest among consumers in online video subscription, International estimates currently has a 60%-plus share we do not expect this emerging segment to become the of China’s online reading traffic market, encompasses major source of revenue for online video platforms any popular reading sites such as qidian.com (起点中文网), time soon. hongxiu.com (红袖添香网) and jjwxc.com (晋江文学网). In its broadest sense, the term IP refers to creations of the human intellect that are protected by law. Within  China: online literature traffic market share (3Q14) the China entertainment industry, however, the term 17k Literature generally refers to literary and artistic works, and Baidu Network fictional figures and images. China has seen a surge in (Zengheng.com) 9.0% the number of movies, TV shows and online games 9.0% based upon popular IP in the past few years. In fact, Zhulang.com the term IP is used in the China entertainment field in 4.0% Tencent (after acquired much the same way as the term “high concept” is Shanda bandied around Hollywood movie circles. Literature) Others 60% The Collins Dictionary defines high concept like so: to 18.0% describe something, usually a book or a movie, that is based on a simple idea regarded as certain to appeal to a large audience. Source: Analysys International

Hence, when industry participants in China talk of Case study: The Journey of Flower (花千骨) monetising IP, they are essentially talking about The Journey of Flower is a popular work of online making high-concept movies/TV series/games that are literature first published on jjwxc.com in 2008. The adapted from well-known or easy-to-communicate story was well received online and a paperback version ideas which they deem to be commercially appealing. that debuted in 2009 has since sold over 1m copies. The TV adaptation rights were sold to Ciwen Media (002343 SZ, not rated), and the series began its first- run transmission in early June 2015 on Hunan TV. It quickly topped the TV ratings and is also the most popular TV series on major online video platforms currently. An official mobile game followed in July 2015 that quickly topped the iOS downloads chart and remains among the top 5 highest-grossing iOS games in China.

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 China: adaptations of The Journey of Flower IP online fiction was released earlier this year. Produced by Le Vision Corporation, a subsidiary of Leshi (300104 SZ, non-rated), the movie generated gross box office receipts of CNY354m.

 China: adaptations of My Sunshine IP

Source: Daiwa, Company

The power of a “fan economy”

Why is it that movies/TV series/games adapted from Source: Daiwa, Company popular online fiction tend to become popular and  commercially successful in China? The concept of a  China: iOS app ranking for The Journey of Flower (July 2015) “fan economy” potentially provides some answers to the question.

The term “fan economy”, pioneered by Xiaomi in China, describes the practice of nurturing a community of fans with the long-term goal of driving purchases by members of the community. The concept goes back to the theory of “1,000 True Fans”, first posited by Kevin Kelly, the founding editor of Wired Magazine. Mr Kelly argued that having a base of just 1,000 true fans, defined as people willing to purchase anything a Source: App Annie content provider produces, would be enough to sustain a profitable business. Case study: My Sunshine (何以笙箫默) My Sunshine is another example of the successful Almost by definition, any popular IP has a group of monetisation of online fiction. The fiction debuted on loyal followers potentially willing to spend money on jjwxc.com in 2003, with the paper edition going on to related products, as these fans have already developed sell over 1m copies since then. The TV adaptation rights an emotional attachment to the IP. Producers like were sold in 2013 and the TV series was broadcast on popular IP because, in the current environment, it is Jiangsu TV and Oriental TV in January 2015. The seen as more likely to be successful than establishing series became the most popular shows on both TV and new characters and stories. online video platforms. A movie based on the original - 32 - China Internet Sector 14 August 2015

According to our research in the market, the adaptation  Global: top-10 box office movies (2014) Global Box rights for most of the leading online fiction have been Ranking Movie Adaptation sold already, and there is a solid pipeline of online Office (USDm) 1 Transformers 4 1,091 Toys fiction-based TV series/movies for the next 2-3 years. 2 Maleficent 757 Fairy tale The price of these adaptation rights has risen steeply in 3 X-men 748 Comic recent years, with the copyright income of some online 4 Guardians of the Galaxy 727 Comic fiction authors having doubled YoY in 2014. 5 Hobbit 3 724 Classic fiction 6 Captain America 2 714 Comic  China: copyright income comparison between online literature 7 The Amazing Spider-Man 2 709 Comic author and published literature author 8 Dawn of the Planet of the Apes 708 Movie series Online literature Copyright income Published literature Copyright income 9 The Hunger Games 3 695 Popular fiction author (CNYm) author (CNYm) 10 Interstellar 660 n.a. 2014 Source: Hollywood Reporter 唐家三少 50 张嘉佳 19.5 辰东 28 郑渊洁 19  Global: top-100 grossing Hollywood movies categorised by 天蚕土豆 25.5 杨红樱 18.5 source of screenplay (2005-14) 耳根 25 刘同 18 Truly Original Screenplay 梦入神机 21.5 江南 17 Fiction 2013 8% 唐家三少 26.5 江南 25.5 4% Original Screenplay - Sequel, 天蚕土豆 20 莫言 24 5% Prequel, Spin-Off Real-Life Event 血红 14.5 郑渊洁 18 6% 38% 我吃西红柿 13 雷欧幻像 17.8 6% Remake 梦入神机 12 杨红樱 17.5 Comic/Graphic Novel 7% Source: West China Journal TV 7% Although we are aware of the suggestion from some 20% Non-Fiction quarters that “IP fatigue” is setting in, we expect online Other literature adaptations and franchise-based literature to continue to be a major genre in the coming 1-2 years. Source: Mr. Porter, IMDB, Daiwa compiled After all, no one can prove the approach is no longer Note: percentages calculated based on US box office working until it stops generating the desired results. Of course, the commercial success or failure of a movie Franchise movies/series are a proven is the result of myriad factors, including the cast, crew, model in the US and Japan plot, visual effect, post production, marketing and even the release date. However, we argue that franchise Globally, we have seen movies and TV series that are movies are more likely to gain consumers’ attention in adapted from popular literature, comic books or stories this day and age, partly because they resonate with an generate significant sums in recent years, likely existing fan base. In short, historical data shows us that because they have an in-built franchise value. the franchise genre is working globally, and as yet we According to The Hollywood Reporter, the top 9 see no signs of a change in consumers’ tastes. movies at the global box office chart in 2014 could all be considered part of the franchise genre (ie, adaptations, sequels or remakes/reboots). Indeed, over Case study: Marvel Studios a longer period, only 38% of the screenplays for the top Marvel Studios has been producing blockbuster movies 100 grossing Hollywood movies in 2005-2014 have and TV series based on its popular comic books for been “truly original”, with the rest derived from more than a decade. Although it started out as a pure established franchises or existing stories. comic-book publisher, Marvel has grown over the years and, along with DC Comics, has created one of the most influential universes of characters globally.

Marvel used to license out adaptation rights for movies or TV series, eg, X-Men to 2oth Century Fox and Spider-Man to Sony Pictures. After going through several rounds of M&A, Marvel Studios was fully acquired by Disney in 2009. Since then, Marvel has stopped licensing out its characters and started producing movies under its own banner based upon a

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single Marvel Cinematic Universe, ie, with plot JPY7.81bn in domestic box-office receipts. Meanwhile, continuity spanning several movies. This strategy has the comic series has spurred consumers’ interest in proved to be a big success, with the 12 movies classical music, and concerts showcasing the classical concerned bringing in gross box-office receipts globally music mentioned in the comic have proven particularly of more than USD8bn. popular.

 Marvel: movie adaptation pipeline (2000-19E)  Nodame Contabile: adaptation and franchise movie/TV Name Premier Date Global Box office (USD m) series/animation/fiction (July 2015) X-men 2000 296 Spider-Man I 2002 821 Hulk 2003 245 X-men II 2003 408 Spider-Man II 2004 783 X-men: The Last Stand 2006 459 Ghost Rider I 2007 228 Spider-Man III 2007 883 The Incredible Hulk 2008 263 Iron Man 2008 585 Wolverine I 2009 373 Iron Man II 2010 624 Captain America I 2011 370 Thor I 2011 449 X-men: First Class 2011 351 Ghost Rider II 2012 149 The Amazing Spider-Man 2012 758 The Avengers 2012 1,519 Thor: The Dark World 2013 645 Iron Man III 2013 1,215 Wolverine II 2013 400 Captain America: The Winter Solider 2014 714 X-men: Days of Future Past 2014 748 The Guardians of Galaxy 2014 774 Avengers: Age of Ultron 2015 1,301 Ant-man 2015 132 (as of 31 July 2015) New Fantastic Four 2015 Deadpool 2016 Captain America: Civil War 2016 Source: Company, Daiwa X-men: Apocalypse 2016 Doctor Strange 2016 Sinister Six 2016 The role of the Internet giants in Wolverine III 2017 Guardians of the Galaxy II 2017 the changing content ecosystem New Fantastic Four II 2017 Thor: Ragnarok 2017 Avengers Infinity War I 2018 In-house production growing in appeal Black Panther 2018 As discussed earlier, we see a rising value for content Captain Marvel 2018 owners and expect more franchised content to emerge Avengers Infinity War II 2019 Inhumans 2019 in the coming years. Over the past few years, we have Source: IMDB seen online video companies starting to invest in in- house content, examples of which include Diors Man Case study: のだめカンタービレ (Nodame (屌丝男士) from Sohu Video and U Can U Bibi (奇葩说) Cantabile 交响情人梦) from iQiyi. We have seen a similar trend in the US, where the SVOD players have been investing in original Nodame Cantabile is an example of how a single IP can content, such as Orange is the new Black from Netflix be monetised through derivative franchises. Nodame and Transparent from Amazon. Contabile originated as a comic series created by Tomoko Ninomiya in 2001, and is a love story We believe in-house content produced by the online concerning 2 young classical musicians. video players in China is likely to grow in popularity.

• The comic series was well received by consumers in First, in-house content tends to be much more Japan, and was subsequently adapted into fiction, profitable than licensed content. Video platforms animation, TV series and movies. The animation broke normally reach out for ads and sponsorship before viewing-figure records for late-night broadcasts, while shooting begins, and hence they have a good handle 2 spin-off movies released in 2010 generated over - 34 - China Internet Sector 14 August 2015

on the potential profitability of shows before committing the investment.  Diors Man: product placement ads (July 2015) • Second, in-house content tends to draw more of an emotional response from the online video audience than does licensed content. In our view, this is because the in-house content producers have a thorough understanding of audience demand, thanks to the large number of data points gathered by video websites. As a result, they can actively reflect changing preferences in their content.

According to Gong Yu, CEO of iQiyi, the company’s

“long-term goal is to have in-house content Source: Daiwa contributing 1/3 of total revenue, total traffic and total content investment — but for now the overall industry Moreover, Sohu is actively exploiting the commercial is still quite far from this goal”. As it stands, in-house value of Diors Man. Jian Bing Man (煎饼侠), a Sohu- content contributes far less revenue and traffic than backed movie featuring the ssame cast and crew as licensed TV content across the market, simply because Diors Man, premiered on 17 July 2015 and quickly the supply of in-house content falls short of that of TV broke domestic box-office records (it has taken production. CNY1bn to date). Sohu estimates the movie will generate a profit of CNY18m for the company in 3Q15. Wee expect the recent success of in-house production to compel the videeo platforms to allocate more of their  Diors Man: adaptation & franchise movies/games (July 2015) budgets to this genre. But we do not expect the videeo platforms to shift spending away from licensed content altogether, given this segment is the major traffic generator currently.

Case study: Diors Man (屌丝男士) Diors Man is a web series produced in-house by Sohu Video. Normally 6-8 episodes per season, the Sohu- Video-exclusive web series has run for 4 seasons since 2012 and is now one of the most popular web series in China. According to DoNews, the cumulative numbeer of views for Diors Man surpassed 2.6bn in May 2015.

Diors (or “Diaosi”) is a slang term created in 2011 that is popular among post-80s and 90s web users. Loosely translated, the term means “loser” or “underdog”, annd is often used to express self-mockery. Similar to US comedy series Louie and Inside Amy Schumer, each episode of Diors Man features several apparently unconnected sketches showing events in the daily liife of a fictionalised version of series creator Dong Chengpen.

The web series is available to all viewers, ie, regardleess of whether they are Sohu Video subscribers or now. The monetisation model revolves around pre-roll ads (around 120 seconds for season four) and sponsorship (sponsors can place soft ads or promote their products Source: Daiwa, Company in the series itself, as illustrated below). We estimatte the production cost per episode to be around CNY400K, compared with a CNY2-3m licence fee for an episode of a popular TV drama.

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In our view, the Internet giants are well placed to ride “BAT”: transforming into the booming entertainment consumption trend in entertainment conglomerates China. As we have discussed, we see a rising value for the content creators, while the upstream business is We expect the 3 largest Chinese Internet companies, highly segmented and has a relatively short history of collectively known as BAT — Baidu, Tencent, and less than 20 years — a situation that we think creates Alibaba— to step up and actively invest in the China an opportunity for consolidation, led by the Internet entertainment industry going forward. giants. And considering the regulatory landscape today, it is more viable for the Internet companies to invest in Currently, the BAT-backed online video players are content creation rather than content distribution (eg, competing head to head for contents and audience. In TV channels). order to differentiate themselves and secure a future supply of content, we expect the major online video We believe there is no group doing a better job of players to invest more in content generation, starting understanding China consumers’ demand for with the in-house production of episodic web-exclusive entertainment than the Internet companies. In the series. fight for consumers’ time, the China Internet giants are well positioned to leverage the profitability of their

existing core business in order to expand into  China: selected movies in which online video/Internet companies have invested (as of August 2015) consumers’ daily entertainment activities. Company Invested Movies Youku - Heyi Picture The Continent (后会无期) In the US, the entertainment sector, having gone 合一影业 Fleet of Time (匆匆那年) through several waves of consolidation, is dominated The Taking of Tiger Mountain 3D (智取威虎山 3D) by 5 key players. As shown below, these media Somewhere Only We Know (有一个地方只有我们知 conglomerates are integrated players that control 道) everything from upstream content production to Let’s Get Married (咱们结婚吧) broadcast channels (for TV mostly) and online video Ever Since We Love (万物生长) Forever Young (栀子花开) channels. Take Walt Disney as an example. The group’s Monster Hunt (捉妖记) sources of revenue and EBIT are highly diverse yet its Alibaba - Ali Picture The Bright Eleven-old Boys (老男孩) business lines all revolve around an ultimate goal of 阿里影业 Mission Impossible: Rogue Nation (碟中谍 5) monetising its world-famous IP. Meanwhile, through Three Lifetimes (三生三世十里桃花) its active M&A strategy, Disney can refresh its content Bai Du Ren (摆渡人) portfolio and capture the attention of its audience, Tencent Video Black & White (痞子英雄 2) regardless of the audience’s preferred screen (TVs, 腾讯视频 Dragon Blade (天降雄狮) cinemas, PCs, and smartphones). Zhongkui-snow Girl and the Dark Crystal (钟馗伏魔) Meet Miss Anxiety (我的早更女友) To our initial question, “what is the role of the Internet Monster Hunt (捉妖记) companies in the China entertainment industry?”, our Sohu Video Jian Bing Man (煎饼侠) answer is that we see large Internet companies in 搜狐视频 China continuing to pour capital into the fast-growing Leshi - LeVision Picture The Bullet Vanishes (消失的子弹) 乐视影业 Tiny Time (小时代) entertainment industry, leading the way in content Boonie Bears: To the Rescue (熊出没之夺宝熊兵) innovation and content distribution, and disrupting The Expendable 2 (敢死队 2) and reshaping the entertainment ecosystem. Coming Home (归来) Source: Daiwa In the medium to long term, we believe the Internet giants are likely to become media conglomerates with multiple avenues through which to monetise content.

The authors would like to thank Yishuo Liu for her great contribution to this report.

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 Disney: brief overview of business lines (as of 1H15)

Walt Disney Group - Entertainment Media

Consumer Studio Parks & Resorts Interactive Media Networks Products Entertainment

Revenue: USD7,670m Revenue: USD619m Revenue: USD2,350m Revenue: USD11,670m Revenue: USD3,543m % of revenue: 30% % of revenue: 2% % of revenue: 9% % of revenue: 45% % of revenue: 14% Operating margin: 18% Operating margin: 16% Operating margin: 42% Operating margin: 31% Operating margin: 27%

Cable Networks Movie California Disneyland Interactive Media Direct Retail Sales ESPN, Disney Channel, Disney Animation Orlando Disneyland Disney.com Licensing ABC Family, SOAPnet, Studio Tokyo Disneyland Disney Family Publishing HK Disneyland Mobile & Social Media UTV, AETN Pixar Animation Studio Paris Disneyland Disney Youtube Marvel Studios Shanghai Disneyland Lucas Studio Broadcast Networks Disney Nature ABC, Live Well, ESPN, Touchstone Studios Disney Cruise Line Interactive Game Disney Broadcasting Walt Disney Pictures

Music Disney Adventure Park Internet ABC, ABC Family Disney Music Group SOAP, ESPN, Hulu Disney Imagineering Stage Play Publication Disney Theatrical Haobo Chuben Group

Source: Company

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Takeaway 2: no clear winner on video subscriptions According to our survey, 34.7% of paying respondents report that they have subscribed for iQiyi’s service, 23.2% for Youku Tudou, 17.4% for Tencent and 9.5% Appendix: how for Sohu Video. Although iQiyi leads the pack in market share among paying users, we think it is too interested is the post- early to declare a clear winner in the video subscription business. 90s generation in  Question: which platform(s) have you subscribed to before? subscribing to video? Sohu Video 9.5%

We surveyed 326 people born between 1980 and 1996 Others iQiyi and asked them several questions regarding their 15.3% 34.7% stance on online video subscription. As our respondents mostly reside in China’s tier-1 and tier-2 cities, the survey may not be a fair representation of the population of the country as a whole. Nonetheless, it Tencent Video yielded useful insights that should help investors 17.4% understand how the post-90s generation think about video subscription. Youku Tudou 23.2% We summarise the major findings of the survey below: Source: Daiwa

Takeaway 1: younger users are more likely Takeaway 3: users have yet to build a to pay for video subscription pattern of long-term paying behaviour Based on our survey, 46.9% of paying respondents From our survey, we found that users born in 1989- have purchased only a one-month video subscription. 1991 show a greater interest in paying for online video Together with the 24.6% of paying respondents who than users born in 1986-88. Respondents born in 1992- have only purchased pay-per-view videos, we consider 96 expressed less interest in paying for such content, that a majority (71.5%) of paying respondents are still and we think this could be attributable to lower only “light paying users”. It may be that these “light disposable income levels, given these respondents are paying users” choose to pay for a short-term still mostly in college. subscription in order to access select subscriber-only

 Question: have you paid for an online video subscription content, which suggests there is no long-term paying before? behaviour as yet. We think much work remains to be done to promote subscription-based services in China. (% of respondents who answered yes, categorised according to their year of birth)  Question: what length of video subscription have you purchased before? 50% 41% Annual fee 36% subscriber 31% 16.9% Per time watch 24.6%

One quarter subscriber 11.5% 1980~1985 1986~1988 1989~1991 1992~1996 One month subscriber Source: Daiwa 46.9%

Source: Daiwa

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Takeaway 4: content is king in terms of differentiation Based on our survey, respondents’ main reason for purchasing online video subscriptions is to watch member-exclusive movies (63.9%), with another 15.8% of paying respondents citing member-exclusive TV series. Only 20.3% of paying respondents are putting down money because they want to skip ads. These findings echo our conclusion that, for the service providers, content is the key to differentiating themselves from other services and attracting users to sign up.

 Question: why do you subscribe to online video packages?

Skip ads Watch TV series 20.3% 15.8%

Watch movies 63.9% Source: Daiwa

- 39 - Information Technology / China BABA US Information Technology / China 14 August 2015

Alibaba Group

Alibaba Group Target (USD): 95.00  95.00 Upside: 29.3% BABA US 12 Aug price (USD): 73.50

Entertainment treasures in the making 1 Buy (unchanged) 2 Outperform • Alibaba Pictures is likely to serve as the group’s flagship 3 Hold entertainment unit; strong content production pipeline 4 Underperform • Developing new business model for video subscription; broad 5 Sell investment should yield long-term benefits • Reaffirming Buy (1) and 12-month target price of USD95

and Peter Chan (陈可辛), while mobile and cross-border e-commerce productions in the pipeline include a business. film adaptation of My Fair Princess (还珠格格) and a TV series adapted

from online fiction, Ghost Blows out Forecast revisions (%) John Choi the Lights (鬼吹灯). Year to 31 Mar 16E 17E 18E (852) 2773 8730 Revenue change --- [email protected] Net profit change --- According to Reuters, Alibaba is Core EPS (FD) change - - - Alex Liu planning to roll out a “Netflix-like” Source: Daiwa forecasts (852) 2848 4976 video subscription service called [email protected] Tmall Box Office (TBO) in mid- Share price performance August 2015. About 90% of TBO’s (USD) (%) content will require upfront 120 130 ■ What's new subscription, with the remainder 108 115 Alibaba Group has great ambitions being made available for free. While 95 100 in the China entertainment segment. few details have been made public to 83 85 70 70 In our view, the company is trying to date, we see the initiative as a good Sep-14 Dec-14 Mar-15 Jun-15 broaden its users’ engagement from strategic fit as Alibaba seeks to Alibaba Gp (LHS) e-commerce transactions into realise its broader ambition of Relative to S&P 500 Index (RHS) entertainment consumption too. By tapping into consumers’ spending investing in or forming partnerships on entertainment. 12-month range 77.33-119.15 Market cap (USDbn) 190.31 with leading entertainment players, 3m avg daily turnover (USDm) 117.48 including Alibaba Pictures, Huayi ■ What we recommend Shares outstanding (m) 2,461 Brothers and Wasu Media, Alibaba We reaffirm our Buy (1) call and 12- Major shareholder SoftBank (32.4%) is keen to its extend its leadership month target price of USD95 based on into the entertainment sector, an a 36x non-GAAP PER applied to our Financial summary (CNY) initiative that we believe offers FY16 EPS forecast. We continue to see Year to 31 Mar 16E 17E 18E substantial monetisation potential. Alibaba being the major beneficiary of Revenue (m) 96,544 131,435 165,665 Operating profit (m) 26,264 41,534 56,492 China’s booming e-commerce sector Net profit (m) 42,978 57,594 72,611 ■ What's the impact in the medium to long run. The main Core EPS (fully-diluted) 16.611 22.040 27.512 Alibaba Pictures (1060 HK, not risks to our call: a slowdown in the EPS change (%) 18.7 32.7 24.8 rated), 49.5%-owned by Alibaba Taobao marketplace and rising Daiwa vs Cons. EPS (%) (3.8) (4.0) (4.8) domestic competition. PER (x) 29.7 22.4 18.0 Group, looks set to be the company’s Dividend yield (%) 0.0 0.0 0.0 flagship entertainment unit. Alibaba DPS 0.000 0.000 0.000 Pictures has announced ■ How we differ PBR (x) 4.9 3.8 3.0 partnerships with renowned On a long-term view, we are more EV/EBITDA (x) 22.1 15.1 10.8 directors Wong Kar Wai (王家卫) positive than the market on Alibaba’s ROE (%) 21.9 20.5 19.9 Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 58 China Internet Sector 14 August 2015

 Key assumptions Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Annual Active buyers (m) n.a. 123 172 255 350 437 533 624 Average spending per active buyers n.a. 5,390 6,262 6,580 6,982 7,379 7,748 8,058 (CNY) T-mall GMV (CNYbn) n.a. 113 253 505 847 1,255 1,727 2,190 Taobao GMV (CNYbn) n.a. 550 824 1,173 1,597 1,970 2,404 2,837 China Retail Total GMV (CNYbn) n.a. 663 1,077 1,678 2,444 3,225 4,131 5,027 Mobile GMV (CNYbn) n.a. 16 79 318 994 1,929 2,917 3,914

 Profit and loss (CNYm) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E China retail business n.a. 13,422 26,970 42,832 59,732 76,055 105,581 133,401 China wholesale business n.a. 2,215 2,197 2,300 3,205 4,365 5,369 6,174 Other Revenue n.a. 4,388 5,350 7,372 13,267 16,125 20,485 26,090 Total Revenue n.a. 20,025 34,517 52,504 76,204 96,544 131,435 165,665 Other income n.a. 0 0 0 0 0 0 0 COGS n.a. (6,554) (9,719) (13,369) (23,834) (32,347) (44,031) (55,995) SG&A n.a. (5,269) (6,502) (8,763) (16,313) (20,937) (25,104) (29,157) Other op.expenses n.a. (3,187) (7,545) (5,452) (12,922) (16,996) (20,767) (24,021) Operating profit n.a. 5,015 10,751 24,920 23,135 26,264 41,534 56,492 Net-interest inc./(exp.) n.a. 190 (1,533) (547) 6,705 30,130 4,708 7,934 Assoc/forex/extraord./others n.a. 327 894 2,429 2,486 2,505 3,090 3,715 Pre-tax profit n.a. 5,532 10,112 26,802 32,326 58,900 49,331 68,141 Tax n.a. (842) (1,457) (3,196) (6,416) (6,963) (10,853) (15,672) Min. int./pref. div./others n.a. (462) (251) (530) (1,761) (1,485) (660) (480) Net profit (reported) n.a. 4,228 8,404 23,076 24,149 50,452 37,818 51,988 Net profit (adjusted) n.a. 6,452 13,869 27,610 34,981 42,978 57,594 72,611 EPS (reported)(CNY) n.a. 1.710 3.660 10.610 10.333 20.501 15.367 21.125 EPS (adjusted)(CNY) n.a. 2.609 6.040 12.695 14.968 17.463 23.403 29.505 EPS (adjusted fully-diluted)(CNY) n.a. 2.548 5.892 11.965 13.992 16.611 22.040 27.512 DPS (CNY) n.a. 0.000 0.000 0.000 0.000 0.000 0.000 0.000 EBIT n.a. 6,404 15,672 29,077 36,338 42,160 57,569 72,727 EBITDA n.a. 7,274 16,607 30,731 40,753 47,509 64,876 80,670

 Cash flow (CNYm) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax n.a. 5,532 10,112 26,802 32,326 58,900 49,331 68,141 Depreciation and amortisation n.a. 870 935 1,654 4,448 6,029 7,307 7,943 Tax paid n.a. (842) (1,457) (3,196) (6,416) (6,963) (10,853) (15,672) Change in working capital n.a. 1,788 3,136 (4,493) 12,706 8,611 12,449 17,762 Other operational CF items n.a. 1,927 1,750 5,612 (1,847) 24,507 28,484 33,998 Cash flow from operations n.a. 9,275 14,476 26,379 41,217 91,085 86,718 112,171 Capex n.a. (2,168) (2,503) (4,776) (22,705) (18,500) (15,000) (9,500) Net (acquisitions)/disposals n.a. (877) (36) (17,111) (15,000) (10,000) (6,000) (6,000) Other investing CF items n.a. 2,920 3,084 (11,110) (15,749) 0 0 0 Cash flow from investing n.a. (125) 545 (32,997) (53,454) (28,500) (21,000) (15,500) Change in debt n.a. 121 26,932 12,789 19,892 2,630 2,761 2,899 Net share issues/(repurchases) n.a. 616 (12,777) 1,923 62,864 0 0 0 Dividends paid n.a. (9) (103) (208) 0 0 0 0 Other financing CF items n.a. (253) (15,458) (5,140) 4,741 0 0 0 Cash flow from financing n.a. 475 (1,406) 9,364 87,497 2,630 2,761 2,899 Forex effect/others n.a. (54) (76) (97) (112) 0 0 0 Change in cash n.a. 9,571 13,539 2,649 75,148 65,214 68,479 99,570 Free cash flow n.a. 8,752 19,745 32,269 48,121 109,585 101,718 121,671 Source: FactSet, Daiwa forecasts

- 41 - China Internet Sector 14 August 2015

 Balance sheet (CNYm) As at 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment n.a. 25,056 36,373 48,553 124,638 189,852 258,331 357,901 Inventory n.a.0000000 Accounts receivable n.a. 1,669 1,734 4,679 12,978 15,447 19,715 23,193 Other current assets n.a. 1,174 5,055 14,601 4,493 4,141 4,184 4,155 Total current assets n.a. 27,899 43,162 67,833 142,109 209,440 282,230 385,249 Fixed assets n.a. 4,164 5,703 7,241 12,244 18,836 22,209 22,074 Goodwill & intangibles n.a. 11,791 11,628 13,699 48,508 78,609 86,899 96,242 Other non-current assets n.a. 3,356 3,293 22,776 52,573 63,315 71,060 77,115 Total assets n.a. 47,210 63,786 111,549 255,434 370,200 462,398 580,679 Short-term debt n.a. 1,283 5,448 10,364 1,990 1,990 1,990 1,990 Accounts payable n.a. 4,659 8,961 11,887 19,834 26,918 36,641 46,597 Other current liabilities n.a. 5,809 9,586 15,133 17,848 22,115 30,693 41,803 Total current liabilities n.a. 11,751 23,995 37,384 39,672 51,024 69,324 90,391 Long-term debt n.a. 0 22,462 30,711 50,603 53,233 55,994 58,893 Other non-current liabilities n.a. 1,046 6,283 2,636 7,088 7,207 7,411 7,610 Total liabilities n.a. 12,797 52,740 70,731 97,363 111,463 132,729 156,894 Share capital n.a. 20,809 32,189 37,445 117,801 117,801 117,801 117,801 Reserves/R.E./others n.a. 10,709 (21,680) 2,294 28,296 129,020 199,881 294,057 Shareholders' equity n.a. 31,518 10,509 39,739 146,097 246,821 317,682 411,858 Minority interests n.a. 2,895 537 1,079 11,974 11,915 11,987 11,927 Total equity & liabilities n.a. 47,210 63,786 111,549 255,434 370,200 462,398 580,679 EV n.a. 1,192,984 1,206,023 1,191,439 1,121,556 1,048,913 977,267 874,536 Net debt/(cash) n.a. (23,773) (8,463) (7,478) (72,045) (134,630) (200,347) (297,018) BVPS (CNY) n.a. 12.735 n.a. 13.489 62.233 100.026 128.819 167.087

 Key ratios (%) Year to 31 Mar 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) n.a. n.a. 72.4 52.1 45.1 26.7 36.1 26.0 EBITDA (YoY) n.a. n.a. 128.3 85.0 32.6 16.6 36.6 24.3 Operating profit (YoY) n.a. n.a. 144.7 85.5 25.0 16.0 36.5 26.3 Net profit (YoY) n.a. n.a. 115.0 99.1 26.7 22.9 34.0 26.1 Core EPS (fully-diluted) (YoY) n.a. n.a. 131.2 103.1 16.9 18.7 32.7 24.8 Gross-profit margin n.a. 67.3 71.8 74.5 68.7 66.5 66.5 66.2 EBITDA margin n.a. 36.3 48.1 58.5 53.5 49.2 49.4 48.7 Operating-profit margin n.a. 32.0 45.4 55.4 47.7 43.7 43.8 43.9 Net profit margin n.a. 32.2 40.2 52.6 45.9 44.5 43.8 43.8 ROAE n.a. 41.0 88.2 188.4 40.0 21.9 20.5 19.9 ROAA n.a. 27.3 25.0 31.5 19.1 13.7 13.8 13.9 ROCE n.a. 35.9 42.0 48.1 24.8 16.1 16.4 16.7 ROIC n.a. 79.9 139.2 122.2 31.1 22.0 25.6 34.0 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate n.a. 15.2 14.4 11.9 19.8 11.8 22.0 23.0 Accounts receivable (days) n.a. 15.2 18.0 22.3 42.3 53.7 48.8 47.3 Current ratio (x) n.a. 2.4 1.8 1.8 3.6 4.1 4.1 4.3 Net interest cover (x) n.a. n.a. 10.2 53.2 n.a. n.a. n.a. n.a. Net dividend payout n.a. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Free cash flow yield n.a. 0.7 1.6 2.7 4.0 9.0 8.4 10.0 Source: FactSet, Daiwa forecasts

 Company profile Alibaba group is the world’s largest e-commerce and m-commerce company in terms of GMV in 2014. Alibaba’s ecosystem comprises B2C, C2C, B2B platforms, payment solutions, and cloud business for third-party service providers and other strategic partners.

- 42 - Information Technology / China 700 HK Information Technology / China 14 August 2015

Tencent Holdings

Tencent Holdings Target (HKD): 175.00  175.00 Upside: 29.7% 700 HK 12 Aug price (HKD): 134.90

Pan-entertainment strategy taking shape 1 Buy (unchanged) 2 Outperform • We see significant synergies between content investment and its 3 Hold core game business 4 Underperform • Digital content spending should drive up user engagement over 5 Sell the next 2-3 years • Reaffirm our Buy (1) rating on the stock and 12-month target price of HKD175

Shanda Literature in 2014), movie ■ How we differ production (Tencent owns around 5% We are more positive than the market of Huayi Brother, a leading China on the revenue potential of WeChat’s movie production house), and online mobile-ad business.

music (QQ Music has formed patent Forecast revisions (%) John Choi partnerships with Sony Music, Year to 31 Dec 15E 16E 17E (852) 2773 8730 Warner Music, etc). Tencent has also Revenue change --- [email protected] been a pioneer in sourcing global Net profit change --- digital content by signing exclusive Core EPS (FD) change - - - Alex Liu agreements with HBO and NBA. Source: Daiwa forecasts (852) 2848 4976 Tencent’s CEO Mr. Pony Ma stated [email protected] publicly that content would be 1 of the Share price performance 2 areas in which the company will (HKD) (%) 175 115 invest in the future (along with mobile ■ What's new 156 108 social networking). Tencent has stepped up investing in 138 100 content for its video business, 119 93 On top of this, we see great synergies 100 85 resulting in rapid traffic share gains in Aug-14 Nov-14 Feb-15 May-15 Aug-15 the past few years. In fact, the number between Tencent’s content investment of daily users for Tencent Video has and its gaming business, as content Tencent (LHS) Relative to HSI (RHS) risen to more than 50m currently, vs. investment adds another layer of 20m a year ago, according to monetisation through in-house IP- 12-month range 105.30-170.50 based games (eg, Tencent launched a Market cap (USDbn) 161.64 iResearch. We believe Tencent will 3m avg daily turnover (USDm) 366.21 continue to spend, and not just on mobile game based on the reality show The Voice of China). We expect Shares outstanding (m) 9,294 video content but also on online Major shareholder Naspers Limited (33.6%) literature and online music. As such, to see more collaboration between Tencent’s content investment and we are confident its core online game Financial summary (CNY) segment will benefit from its vast games business in the future. Year to 31 Dec 15E 16E 17E content reserves, on the back of Revenue (m) 98,091 127,862 159,254 ■ What we recommend Operating profit (m) 40,376 51,082 62,255 subsequent adaptations and cross- Net profit (m) 30,429 39,249 48,689 selling opportunities. We reaffirm our Buy (1) rating and 12- month TP of HKD175, based on a Core EPS (fully-diluted) 3.237 4.175 5.179 EPS change (%) 26.4 29.0 24.1 ■ What's the impact target PER of 39x applied to the Daiwa vs Cons. EPS (%) 1.1 (0.7) (4.0) average of our 2015-16E GAAP EPS. PER (x) 34.3 26.6 21.4 Tencent’s investment portfolio covers Dividend yield (%) 0.4 0.6 0.7 almost every subsector in Our target multiple represents a 25% premium to its China Internet peers. DPS 0.451 0.629 0.783 China’s content supply chain, PBR (x) 8.7 7.0 5.6 Key risk: higher-than-expected including online literature (Tencent EV/EBITDA (x) 20.1 15.6 12.3 Literature acquired and merged with marketing expenses. ROE (%) 30.7 29.5 29.2 Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 58 China Internet Sector 14 August 2015

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Monthly Active Users (MAU) of n.a. n.a. n.a. 355 500 660 766 827 WeChat (m) WeChat implied revenues (CNYbn) 0 0 0 3 12 24 39 54 Online game revenue (CNYbn) 9.5 15.8 22.8 32.0 44.8 54.6 64.1 71.4 Community value-added services 6.0 7.2 9.1 13.0 18.6 22.7 27.3 32.0 revenue (CNYbn)

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Value-added services (VAS) 18,198 26,314 35,718 45,985 63,310 77,243 91,374 103,383 Online advertising 1,373 1,992 3,382 5,034 8,308 16,779 30,383 47,019 Other Revenue 75 190 4,793 9,418 7,314 4,070 6,104 8,851 Total Revenue 19,646 28,496 43,894 60,437 78,932 98,091 127,862 159,254 Other income 294 890 552 2,219 4,435 4,317 5,102 5,589 COGS (6,320) (9,928) (18,207) (27,778) (30,873) (38,695) (51,962) (66,278) SG&A (3,004) (5,265) (8,146) (12,003) (17,155) (17,111) (23,143) (28,506) Other op.expenses (778) (1,939) (2,612) (3,590) (4,797) (6,227) (6,777) (7,803) Operating profit 9,838 12,254 15,479 19,285 30,542 40,376 51,082 62,255 Net-interest inc./(exp.) 255 504 836 1,314 494 775 900 1,200 Assoc/forex/extraord./others (180) (659) (1,264) (1,319) (2,023) (3,941) (4,300) (4,200) Pre-tax profit 9,913 12,099 15,051 19,281 29,013 37,210 47,682 59,255 Tax (1,798) (1,874) (2,266) (3,718) (5,125) (7,030) (8,583) (10,666) Min. int./pref. div./others (62) 22 53 61 79 249 150 100 Net profit (reported) 8,054 10,247 12,838 15,624 23,967 30,429 39,249 48,689 Net profit (adjusted) 8,054 10,247 12,838 15,624 23,967 30,429 39,249 48,689 EPS (reported)(CNY) 0.886 1.127 1.405 1.706 2.596 3.274 4.223 5.239 EPS (adjusted)(CNY) 0.886 1.127 1.405 1.706 2.596 3.274 4.223 5.239 EPS (adjusted fully-diluted)(CNY) 0.866 1.103 1.378 1.673 2.561 3.237 4.175 5.179 DPS (CNY) 0.110 0.150 0.200 0.240 0.360 0.451 0.629 0.783 EBIT 9,838 12,254 15,479 19,285 30,542 40,376 51,082 62,255 EBITDA 10,616 14,192 18,092 22,875 35,339 46,603 57,859 70,058

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 9,913 12,099 15,051 19,281 29,013 37,210 47,682 59,255 Depreciation and amortisation 778 1,939 2,612 3,590 4,374 5,479 6,733 8,120 Tax paid (1,542) (1,836) (2,225) (3,118) (4,481) (7,266) (8,289) (10,301) Change in working capital 3,501 15,194 21,601 27,492 9,024 5,418 9,329 9,801 Other operational CF items (366) (14,038) (17,610) (22,871) (10,272) 2,995 1,013 89 Cash flow from operations 12,285 13,358 19,429 24,374 27,658 43,835 56,467 66,964 Capex (2,024) (4,060) (3,970) (4,788) (6,033) (7,239) (8,108) (9,081) Net (acquisitions)/disposals 0 (6,875) (4,659) 8,059 (23,993) (1,792) (1,900) (2,014) Other investing CF items (9,991) (3,632) (6,772) (21,112) 100 76 76 76 Cash flow from investing (12,015) (14,566) (15,401) (17,841) (29,926) (8,956) (9,932) (11,019) Change in debt 0 2,917 (7,041) 1,334 19,252 14,795 10,719 10,790 Net share issues/(repurchases) (144) (887) 218 (1,017) 0 0 0 0 Dividends paid (624) (895) (1,225) (1,536) (3,323) (3,323) (4,190) (5,842) Other financing CF items 4,880 3,238 5,662 2,927 8,825 (540) (567) (595) Cash flow from financing 4,112 4,373 (2,386) 1,708 24,754 10,932 5,961 4,353 Forex effect/others (52) (172) (2) (103) 5,318 0 0 0 Change in cash 4,331 2,993 1,640 8,138 27,803 45,811 52,497 60,297 Free cash flow 10,261 9,298 15,460 19,586 21,625 36,596 48,359 57,882 Source: FactSet, Daiwa forecasts

- 44 - China Internet Sector 14 August 2015

 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 22,134 26,328 27,189 39,851 53,511 99,262 151,725 212,018 Inventory 0 0 568 1,384 244 250 260 270 Accounts receivable 1,715 2,021 2,354 2,955 4,588 5,702 7,432 9,257 Other current assets 1,524 7,155 6,398 9,496 16,978 21,099 27,503 34,255 Total current assets 25,374 35,503 36,509 53,686 75,321 126,313 186,920 255,799 Fixed assets 3,293 5,885 7,899 10,734 11,748 15,879 18,557 20,910 Goodwill & intangibles 573 3,780 4,719 4,103 9,304 8,617 7,839 6,971 Other non-current assets 6,591 11,636 26,128 38,712 74,795 101,515 105,485 109,010 Total assets 35,830 56,804 75,256 107,235 171,168 252,323 318,801 392,690 Short-term debt 5,299 8,020 1,077 2,589 3,215 7,185 7,904 8,694 Accounts payable 1,380 2,244 4,212 6,680 8,683 10,196 13,459 16,863 Other current liabilities 6,343 10,919 15,376 23,998 38,137 48,139 62,349 77,333 Total current liabilities 13,022 21,183 20,665 33,267 50,035 65,520 83,712 102,890 Long-term debt 0 3,733 7,517 9,141 25,028 38,592 48,592 58,592 Other non-current liabilities 967 2,799 4,926 6,364 13,979 16,849 19,142 20,507 Total liabilities 13,989 27,716 33,108 48,772 89,042 120,961 151,446 181,989 Share capital 0 0 0 0 0 0 0 0 Reserves/R.E./others 21,757 28,464 41,297 57,945 80,013 118,081 147,840 185,487 Shareholders' equity 21,757 28,464 41,298 57,945 80,013 118,081 147,840 185,487 Minority interests 84 625 851 518 2,111 13,281 19,514 25,214 Total equity & liabilities 35,830 56,804 75,256 107,235 171,166 252,323 318,801 392,690 EV 1,014,511 1,014,058 1,007,318 992,195 954,794 938,432 903,320 859,958 Net debt/(cash) (16,835) (14,574) (18,595) (28,121) (25,268) (53,485) (95,230) (144,732) BVPS (CNY) 2.370 3.094 4.457 6.224 8.668 12.706 15.908 19.959

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 57.9 45.0 54.0 37.7 30.6 24.3 30.4 24.6 EBITDA (YoY) 61.9 33.7 27.5 26.4 54.5 31.9 24.2 21.1 Operating profit (YoY) 63.4 24.6 26.3 24.6 58.4 32.2 26.5 21.9 Net profit (YoY) 56.2 27.2 25.3 21.7 53.4 27.0 29.0 24.1 Core EPS (fully-diluted) (YoY) 55.1 27.4 25.0 21.4 53.1 26.4 29.0 24.1 Gross-profit margin 67.8 65.2 58.5 54.0 60.9 60.6 59.4 58.4 EBITDA margin 54.0 49.8 41.2 37.8 44.8 47.5 45.3 44.0 Operating-profit margin 50.1 43.0 35.3 31.9 38.7 41.2 40.0 39.1 Net profit margin 41.0 36.0 29.2 25.9 30.4 31.0 30.7 30.6 ROAE 47.5 40.8 36.8 31.5 34.7 30.7 29.5 29.2 ROAA 30.2 22.1 19.4 17.1 17.2 14.4 13.7 13.7 ROCE 49.6 36.0 33.8 31.9 33.8 28.1 25.5 24.8 ROIC 261.8 106.1 69.1 57.8 57.7 48.6 55.8 73.9 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 18.1 15.5 15.1 19.3 17.7 18.9 18.0 18.0 Accounts receivable (days) 27.4 23.9 18.2 16.0 17.4 19.1 18.7 19.1 Current ratio (x) 1.9 1.7 1.8 1.6 1.5 1.9 2.2 2.5 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 12.4 13.3 14.2 14.1 13.9 13.8 14.9 14.9 Free cash flow yield 1.0 0.9 1.5 1.9 2.1 3.5 4.7 5.6 Source: FactSet, Daiwa forecasts

 Company profile Tencent is the largest and most used Internet service portal in China. Over the past decade, the company has been able to maintain steady earnings growth under its user-oriented strategy. On 16 June 2004, it was listed on the main board of the Hong Kong Stock Exchange.

- 45 - Information Technology / China BIDU US Information Technology / China 14 August 2015

Baidu

Baidu Target (USD): 200.00  175.00 Upside: 8.8% BIDU US 12 Aug price (USD): 160.82

Good content positioning but growing strain on profitability 1 Buy 2 Outperform • Well positioned in the online video sector through iQiyi and 3 Hold (unchanged) PPS; expect further investment in licensed & in-house content 4 Underperform • Potential spin-off of video business would alleviate capital 5 Sell pressure and unlock value in the medium term • Reiterate Hold (3); lower target price to USD175

the past 2 years, launching popular ■ How we differ web-exclusive shows including U We are more cautious than the Can U Bibi (奇葩说) and The Lost market on the margin outlook due to Tomb (盗墓笔记). We expect the Baidu’s aggressive O2O investments.

company to further increase in- Forecast revisions (%) John Choi house content investment relative to Year to 31 Dec 15E 16E 17E (852) 2773 8730 licensed content down the road. Revenue change --- [email protected] Net profit change (2.4) (10.2) (2.0) Core EPS (FD) change (2.6) (10.4) (2.2) iQiyi’s management has consistently Alex Liu Source: Daiwa forecasts said it is aiming for an independent (852) 2848 4976 [email protected] listing in the future, preferably on Share price performance China’s A-share market. According (USD) (%) to Shanghai Security Journal, iQiyi 255 110 ■ What's new is likely to be listed on the planned 231 99 We think Baidu is well-positioned in “Strategic Emerging Board” of the 208 88 China’s online video sector with its Shanghai Stock Exchange as early as 184 76 April 2016. We think a potential 160 65 strong content sourcing capability Aug-14 Nov-14 Feb-15 May-15 Aug-15 spin-off of iQiyi would alleviate the and ongoing efforts to innovate in- Baidu (LHS) house content genres. Nonetheless, capital pressure on Baidu and Relative to S&P 500 Index (RHS) we see the company’s investment in provide valuation support in the content weighing on its near-term medium term. All in, we lower our 12-month range 167.94-250.34 2015-17E earnings by 2.4-10.4% due Market cap (USDbn) 58.83 operating margin outlook. 3m avg daily turnover (USDm) 728.21 to higher content and marketing Shares outstanding (m) 350 ■ What's the impact expenses and a lower CNY rate. Major shareholder Robin Yanhong Li (15.9%) Baidu acquired iQiyi and PPS, 2 leading online video platforms, in ■ What we recommend Financial summary (CNY) 2013 and 2014, respectively. With the We reiterate our Hold (3) call and Year to 31 Dec 15E 16E 17E 2 sites combined, Baidu now controls lower our 12-month TP to USD175 Revenue (m) 67,235 89,253 115,625 (from USD200), based on an Operating profit (m) 10,596 14,624 22,818 one of the largest online video Net profit (m) 12,092 15,581 23,182 properties in China. As a relatively unchanged target PER of 25x (the Core EPS (fully-diluted) 34.286 44.179 65.731 late-comer to the industry, iQiyi has stock’s average past-3-year 12-month EPS change (%) (5.7) 28.9 48.8 been able to leapfrog some of its forward PER) applied to our 2016E Daiwa vs Cons. EPS (%) (0.0) (3.8) 1.1 GAAP EPS. Key upside risk: lower- PER (x) 31.3 24.3 16.3 competitors by investing in the right Dividend yield (%) 0.0 0.0 0.0 licensed content genre, namely than-expected marketing expenses for DPS 0.000 0.000 0.000 domestic TV dramas & reality shows. the O2O business. Key downside risk: PBR (x) 5.8 4.7 3.6 In addition, iQiyi has accelerated its lower-than-expected monetisation of EV/EBITDA (x) 25.5 17.9 11.2 efforts on in-house production over the mobile search business. ROE (%) 20.5 21.5 25.3 Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 58 China Internet Sector 14 August 2015

 Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Online marketing services revenue 7,912.9 14,489.8 22,245.6 31,802.2 48,487.4 65,847.6 86,529.3 108,894.3 (CNYm) Other services revenue (CNYm) 2.2 11.0 60.4 141.7 564.7 1,387.2 2,724.0 6,730.4 Selling and marketing expenses as 9.8 8.4 8.3 12.6 17.0 23.5 22.5 20.5 percentage of revenue (%) R&D expenses as pencentage of 9.1 9.2 10.3 12.9 14.2 16.5 15.8 14.5 revenue (%)

 Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Online marketing services 7,913 14,490 22,246 31,802 48,487 65,848 86,529 108,894 Other services 2 11 60 142 565 1,387 2,724 6,730 Other Revenue 0 0000000 Total Revenue 7,915 14,501 22,306 31,944 49,052 67,235 89,253 115,625 Other income 449 885 1,513 2,636 3,948 2,684 3,730 5,142 COGS (2,149) (3,897) (6,449) (11,472) (18,885) (26,511) (36,162) (47,135) SG&A (1,089) (1,693) (2,501) (5,174) (10,382) (19,059) (24,366) (28,906) Other op.expenses (1,167) (2,219) (3,817) (6,743) (10,929) (13,752) (17,832) (21,907) Operating profit 3,959 7,577 11,051 11,192 12,804 10,596 14,624 22,818 Net-interest inc./(exp.) 67 336 759 813 974 1,531 1,730 1,903 Assoc/forex/extraord./others 35 (103) 156 180 307 606 802 1,043 Pre-tax profit 4,061 7,809 11,965 12,185 14,085 12,733 17,155 25,764 Tax (536) (1,189) (1,574) (1,829) (2,231) (2,371) (3,190) (4,675) Min. int./pref. div./others 0 18 65 163 943 1,731 1,615 2,093 Net profit (reported) 3,525 6,639 10,456 10,519 12,797 12,092 15,581 23,182 Net profit (adjusted) 3,525 6,639 10,456 10,519 12,797 12,092 15,581 23,182 EPS (reported)(CNY) 10.128 19.027 29.926 30.066 36.499 34.417 44.348 65.981 EPS (adjusted)(CNY) 10.128 19.027 29.926 30.066 36.499 34.417 44.348 65.981 EPS (adjusted fully-diluted)(CNY) 10.096 18.988 29.892 30.023 36.358 34.286 44.179 65.731 DPS (CNY) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 EBIT 3,959 7,577 11,051 11,192 12,804 10,596 14,624 22,818 EBITDA 4,408 8,462 12,564 13,828 16,752 13,280 18,353 27,960

 Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 4,061 7,809 11,965 12,185 14,085 12,733 17,155 25,764 Depreciation and amortisation 449 885 1,513 2,636 3,948 2,684 3,730 5,142 Tax paid (536) (1,189) (1,574) (1,829) (2,231) (2,371) (3,190) (4,675) Change in working capital 746 592 781 967 3,249 (1,441) 2,257 3,527 Other operational CF items (20) 81 (689) (166) (1,503) (168) 67 (260) Cash flow from operations 4,700 8,179 11,996 13,793 17,548 11,436 20,020 29,498 Capex (895) (1,762) (2,311) (2,757) (4,827) (5,876) (7,570) (10,594) Net (acquisitions)/disposals (71) (2,469) (1,031) 10,240 39,498 (1,597) (1,626) (2,000) Other investing CF items (252) (10,019) (10,408) (30,806) (57,138) (365) (442) (529) Cash flow from investing (1,218) (14,251) (13,750) (23,323) (22,468) (7,838) (9,638) (13,123) Change in debt 86 2,359 9,389 6,025 7,741 1,750 1,746 1,730 Net share issues/(repurchases) 39 23 57 1,397 193 0 0 0 Dividends paid 0 0 0 0 (338) 0 0 0 Other financing CF items 0 44 100 1,397 1,847 0 0 0 Cash flow from financing 125 2,426 9,546 8,819 9,442 1,750 1,746 1,730 Forex effect/others (6) (9) (12) (201) 80 0 0 0 Change in cash 3,602 (3,654) 7,780 (911) 4,602 5,348 12,128 18,105 Free cash flow 3,805 6,417 9,685 11,036 12,720 5,560 12,450 18,904 Source: FactSet, Daiwa forecasts

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 Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 8,197 14,662 32,880 38,686 58,084 63,432 75,560 93,665 Inventory 00000000 Accounts receivable 297 600 1,253 2,221 3,664 5,023 6,668 8,638 Other current assets 289 586 541 2,122 4,093 7,231 10,632 14,601 Total current assets 8,782 15,848 34,674 43,029 65,841 75,686 92,859 116,904 Fixed assets 1,622 2,744 3,888 5,370 8,705 12,186 16,354 22,186 Goodwill & intangibles 179 3,348 5,465 20,495 20,993 22,302 23,600 25,221 Other non-current assets 464 1,400 1,642 2,092 4,122 4,708 5,444 6,353 Total assets 11,048 23,341 45,669 70,986 99,662 114,882 138,258 170,663 Short-term debt 0 126 0 0 93 93 93 93 Accounts payable 1,318 2,545 3,807 7,362 12,965 13,074 16,842 21,953 Other current liabilities 1,234 1,735 4,430 3,671 7,213 9,221 11,509 14,250 Total current liabilities 2,552 4,407 8,237 11,033 20,271 22,388 28,445 36,297 Long-term debt 86 2,278 9,693 17,229 23,507 25,507 27,507 29,507 Other non-current liabilities 5 331 524 2,058 1,378 1,128 874 604 Total liabilities 2,643 7,015 18,454 30,321 45,156 49,023 56,826 66,408 Share capital 00000000 Reserves/R.E./others 8,406 16,228 27,088 38,425 53,421 64,774 80,346 103,169 Shareholders' equity 8,406 16,228 27,089 38,425 53,421 64,774 80,346 103,169 Minority interests 0 98 127 2,240 1,085 1,085 1,085 1,085 Total equity & liabilities 11,048 23,341 45,669 70,986 99,662 114,882 138,257 170,662 EV 367,637 363,586 352,687 356,531 342,349 339,001 328,873 312,768 Net debt/(cash) (8,111) (12,259) (23,187) (21,457) (34,484) (37,832) (47,960) (64,065) BVPS (CNY) 24.120 46.479 77.472 109.690 152.498 184.907 229.361 294.514

 Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 78.0 83.2 53.8 43.2 53.6 37.1 32.7 29.5 EBITDA (YoY) 129.0 92.0 48.5 10.1 21.1 (20.7) 38.2 52.3 Operating profit (YoY) 146.7 91.4 45.9 1.3 14.4 (17.2) 38.0 56.0 Net profit (YoY) 137.4 88.3 57.5 0.6 21.7 (5.5) 28.9 48.8 Core EPS (fully-diluted) (YoY) 136.4 88.1 57.4 0.4 21.1 (5.7) 28.9 48.8 Gross-profit margin 72.8 73.1 71.1 64.1 61.5 60.6 59.5 59.2 EBITDA margin 55.7 58.4 56.3 43.3 34.2 19.8 20.6 24.2 Operating-profit margin 50.0 52.3 49.5 35.0 26.1 15.8 16.4 19.7 Net profit margin 44.5 45.8 46.9 32.9 26.1 18.0 17.5 20.0 ROAE 53.6 53.9 48.3 32.1 27.9 20.5 21.5 25.3 ROAA 41.0 38.6 30.3 18.0 15.0 11.3 12.3 15.0 ROCE 59.8 55.7 39.7 23.6 18.8 12.5 14.6 18.8 ROIC 1,471.9 294.5 237.1 81.9 54.9 35.9 38.7 50.7 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 13.2 15.2 13.2 15.0 15.8 18.6 18.6 18.1 Accounts receivable (days) 10.6 11.3 15.2 19.8 21.9 23.6 23.9 24.2 Current ratio (x) 3.4 3.6 4.2 3.9 3.2 3.4 3.3 3.2 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Free cash flow yield 1.0 1.7 2.6 2.9 3.4 1.5 3.3 5.0 Source: FactSet, Daiwa forecasts

 Company profile Founded in 2000, Baidu is the world's largest Chinese-language search engine. Its Internet search services cover web pages, news, images, documents, and multimedia files. Baidu had about 524,000 active online marketing customers in 1Q15. As at the end of 1Q15, Baidu had over 600m monthly active users.

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Youku Tudou

Youku Tudou Target (USD): n.a. Up/downside: - YOKU US 12 Aug price (USD): 19.32

Leading video platform looking to become entertainment giant Not Rated

• Leading online video platform focusing on web-native content • Transforming into integrated entertainment platform; Alibaba’s key strategic partner in the entertainment sector • Ads remain the main revenue contributor for now; consumer business gaining traction

Transforming from online 43% YoY), equivalent to 78% of its video platform to integrated total revenue. entertainment platform. On 6 Youku Tudou’s consumer business August, Youku Tudou announced includes online video subscription, plans to change its name to Heyi mobile game joint operation, and John Choi Group (合一集团), which interactive live entertainment. (852) 2773 8730 management believes highlights its Consumer business revenue totalled [email protected] ambition to transform from a pure CNY120.8m (up 706% YoY) in 1Q15, online video content player into an and accounted for 11% of Youku’s Alex Liu integrated entertainment platform. net revenue. Management believes (852) 2848 4976 Youku Tudou formed a movie Youku Tudou’s consumer business is [email protected] studio, Heyi Picture, back in 2H14. still in its early stages and offers

Heyi Picture is involved in movie significant growth potential. ■ Background publishing and co-produced 11 ■ Valuation The product of a merger between movies with total box office receipts Youku and Tudou in 2012, Youku of CNY28bn since its establishment As of 12 August, Youku Tudou is Tudou is now the leading online in 2014. trading at price-to-sales ratios of video platform in China. Following a 3.3x 2015E and 2.7x 2016E, based strategic investment in May 2014, China’s leading mobile video on Bloomberg consensus data. Alibaba Group and a related party platform. According to the CNNIC, are the largest shareholders in Youku Tudou reached more than Youku Tudou, with a combined 48.3% of China’s mobile online 20.7% equity stake. video users in 2014, followed by iQiyi and Tencent Video. Mobile ■ Highlights platforms accounted for an Share price performance Largest web-native video estimated 75% of traffic and 65% of content platform in China. Web- user time spent on Youku in 1Q15. (USD) (%) 31 135 native content — including original According to the management, mobile advertising revenue now 26 114 productions, user-generated content 22 93 accounts for more than 40% of (UGC) and professionally-generated 17 71 content (PGC) — accounts for over Youku Tudou’s total ad revenue. 12 50 50% of Youku Tudou’s total video Aug-14 Nov-14 Feb-15 May-15 Aug-15 Ads the main revenue Youku (LHS) views. According to our discussions Relative to S&P 500 Index (RHS) with management, it is determined contributor; consumer to focus on its web-native content business gaining traction. In 12-month range 12.36-30.78 strategy going forward as a way to 1Q15, the company’s advertising Market cap (USDbn) 3.30 differentiate it from competitors. revenue totalled CNY892.7m (up 3m avg daily turnover (USDm) 19.72 Source: FactSet, Daiwa

See important disclosures, including any required research certifications, beginning on page 58 China Internet Sector 14 August 2015

 Youku Tudou: original productions – Unexpectedness (万万没想到); Detective Di Ren Jie (名侦探狄仁杰); Lv Xing (侣行)

Leading video platform looking to become entertainment giant

Company background Source: Company Youku Tudou is China’s leading online video company. Its online video platform enables users to search, view  Youku Tudou: PGC: Bao Zou Man Hua (暴走漫画); Luogic and share high-quality video content quickly and easily Show (罗辑思维) across multiple devices. The company monetises its video services by sub-licensing content, via in-video ads, display ads, sponsorship, product placements and other forms of advertising.

In May 2014, Alibaba Group announced an investment of USD1.09bn in Youku Tudou in exchange for a 16.5% equity stake. Based on its most recent annual report, Alibaba and its related party, Yunfung Fund, now have a 20.7% holding in Youku Tudou, making them the largest shareholders. Source: Company  Youku Tudou: major shareholders (as of 31 March 2015) Name % of equity holding Transforming into integrated Alibaba Group & Yunfung Fund 20.70% entertainment platform 1 Verg Holding (controlled by CEO Victor Koo) 17.90% Source: Company Earlier this month Youku Tudou announced plans to rename itself Heyi Group (in Chinese, heyi means “integrated as one”). According to management, Youku Business highlights will invest over CNY10bn in cash and resources to support the creation of web-native content. China’s largest web native video platform Youku is the largest web native content platform in Youku Tudou entered the movie publishing and China, and web-native content currently accounts for production business via wholly-owned subsidiary Heyi more than 50% of the video views on the platform. Picture back in August 2014. A year later, Youku’s management announced another 5 entertainment- Youku sources content through 4 major channels: 1) related investments: AcFun, JIAE.com (加意新品), licensed content, 2) professionally-generated content Rongyiedu.com (容艺教育学校), Joyme.com (着迷) and (PGC), 3) user-generated content (UGC), and 4) Youku Luogic Show (逻辑思维). Tudou’s originally produced content.  Youku Tudou: recent investments  Youku Tudou: content-sourcing strategies Target company Investment description Content source Cost Revenue model AcFun Leading video community in China focusing on animation popular Licensed content Licensing fee Advertising revenue & sub-licensing with the younger generation income JIAE.com Decorative household appliance e-commerce platform PGC 30% advertising revenue 70% of advertising revenue Rongyiedu.com Online education platform UGC n.a. Advertising revenue Joyme.com Mobile game online forum Original Production Production cost Advertising revenue Luogic Show Media Source: Daiwa Source: Daiwa

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Online advertising remains the biggest  Yoouku Tudou: screenshot of prroduct placement ads source of revenue Addvertising is still the biggest revenue contributor fofor Youku, accounting for 78% of total revenue in 1Q15. Whhile the company now charges the same price for its mobile and PC ads, mobile devices account for over 75% of traffic and 65% of user time spent on Youku Tudou. In 1Q15, mobile contributed over 40% of Youku’s total advertising revenue.

Currently, the company is testing new ad formats, suuch as a “view to buy” function that allows viewers to purchase speciffic items through ads shown during a video. Soft advvertising (ie, content sponsorship andd in- video product placements) are also gaining popularriity among advertisers. Youku’s major ad formats include Source: Company pre-roll ads, in-stream ads and product placement ads. Consumer business is gaining traction  Youku Tudou: screenshot of pre-roll ads Youku’s consumer business includes online video subscription, a mobile game joint operation and interactive live entertainment. The consumer business generated revenue of CNY120.8m (up 706% YoY) in 1Q15, and accounted for 11% of Youku’s net revenue.

According to management, tthe company’s 1Q15 subscription revenue alone grew 30% QoQ, and there are now more than 1m video subscribers. Users purchasing Youku’s video subscriptions can see ad-free videos and gain access to an exclusive content library featuring thousands of moviies. Meanwhile, Youku’s interactive live entertainment platform, Laifeng (来疯), enables viewers to watch livve shows and interact with

Source: Company the shows’ online hosts.

 Youku Tudou: screenshot of in-stream ads  Yoouku Tudou: screenshot of Youku’s game centre

Source: Company

- 51 - China Internet Sector 14 August 2015

 Youku Tudou: screenshot of Lai Feng (live performance)  Youku: historical quarterly revenue, content cost & operating income (1Q12-1Q15) (CNYm) 1,500

1,000

500

(500)

(1,000) Source: Company 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 Net revenue Content cost Operating Loss Source: Company Strategic partnership with Alibaba Valuation

Alibaba and Yunfeng Fund, a private equity fund whose Youku Tudou is currently trading at 3.3x 2015E PSR general partner is Jack Ma, together acquired an 18.5% and 2.7x 2016E PSR, based on Bloomberg consensus stake in Youku Tudou in May 2014. They further data. increased their shareholding to 20.7%, making them the largest shareholders of Youku Tudou. Youku’s  Youku Tudou: historical forward 12-month PSR (2014-15E) management noted that the strategic partnership with 6 Alibaba will focus on an innovative new business model as well as new ad formats. 5

4 In May and July 2015, there was market interest in the possibility of a merger between Youku Tudou and iQiyi 3 (Baidu’s online video platform). Gong Yu, the CEO of 2 iQiyi, publicly stated via Weibo that there were no plans for a merger, and iQiyi officially refuted similar 1 chatter in July via ifeng.com (凤凰新闻). 0

Jul-15 Apr-15 Oct-14

Also, according to ifeng in May 2015, Alibaba is seeking Jan-15 Jun-15 Feb-15 Mar-15 Aug-15 Aug-14 Sep-14 Nov-14 Dec-14 May-15 to privatise Youku Tudou. To date, there has been no Source: Bloomberg official response to the story by either Youku or Alibaba.  Youku Tudou: revenue forecast revisions (2014-15E) (CNYm) 10,000 Financial results 8,000 For 1Q15, Youku Tudou’s total revenue reached 6,000 CNY1.06bn, up 51% YoY. For the same period its 4,000 advertising revenue was CNY892.7m (up 43% YoY) and its consumer revenue was CNY120.8m (up 706% YoY). 2,000 0 The company’s operating loss widened QoQ in 1Q15 Jul-15 Oct-14 Apr-15 Jan-15 Jun-15 Feb-15 Mar-15 Aug-14 Sep-14 Nov-14 Dec-14 Aug-15 due to heavier spending on content and increased May-15 bandwidth costs. Its non-GAAP net loss for the quarter Revenue forecast 2016E Revenue forecast 2015E was CNY482m, vs. a CNY157m loss in the Source: Bloomberg corresponding period of 2014. Its content costs for 1Q15 totalled CNY669m, a 105% YoY increase, while its bandwidth costs totalled CNY307m, up 52% YoY.

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 Youku Tudou: non-GAAP EPS forecast revisions (2014-15E) (CNY) 8 6 4 2 0 (2) (4) (6) (8) Jul-15 Oct-14 Apr-15 Jan-15 Jun-15 Feb-15 Mar-15 Aug-14 Sep-14 Nov-14 Dec-14 Aug-15 May-15 Non-GAAP EPS forecast 2016E Non-GAAP EPS forecast 2015E Source: Bloomberg

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Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Banking; Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Iris PARK (82) 2 787 9165 [email protected] Regional Deputy Head of Asia Pacific Research Consumer/Retail Rohan DALZIELL (852) 2848 4938 [email protected] SK KIM (82) 2 787 9173 [email protected] Regional Head of Product Management IT/Electronics – Semiconductor/Display and Tech Hardware Kevin LAI (852) 2848 4926 [email protected] Jun Yong BANG (82) 2 787 9168 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) Oil; Chemicals; Tyres Christie CHIEN (852) 2848 4482 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Macro Economics (Regional); Banking; Insurance (Taiwan) Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Junjie TANG (852) 2773 8736 [email protected] Macro Economics (China) TAIWAN Jonas KAN (852) 2848 4439 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Head of Hong Kong and China Property Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Cynthia CHAN (852) 2773 8243 [email protected] (Regional) Property (China) Steven TSENG (886) 2 8758 6252 [email protected] Leon QI (852) 2532 4381 [email protected] IT/Technology Hardware (PC Hardware) Banking (Hong Kong/China); Broker (China); Insurance (China) Christine WANG (886) 2 8758 6249 [email protected] Anson CHAN (852) 2532 4350 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Consumer (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] Jamie SOO (852) 2773 8529 [email protected] IT/Technology Hardware (Handsets and Components) Gaming and Leisure (Hong Kong/China) Helen CHIEN (886) 2 8758 6254 [email protected] Dennis IP (852) 2848 4068 [email protected] Small/Mid Cap Power; Utilities; Renewables and Environment (Hong Kong/China) John CHOI (852) 2773 8730 [email protected] INDIA Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Becky HAN (852) 2848 4464 [email protected] Head of India Research; Strategy; Banking/Finance Small/Mid Cap (Regional) Saurabh MEHTA (91) 22 6622 1009 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Capital Goods; Utilities Head of Transportation (Hong Kong/China); Transportation (Regional) Brian LAM (852) 2532 4341 [email protected] SINGAPORE Transportation – Aviation (Hong Kong/China); Railway; Construction and Engineering Ramakrishna MARUVADA (65) 6499 6543 [email protected] (China) Head of Singapore Research; Telecommunications (China/ASEAN/India) Jibo MA (852) 2848 4489 [email protected] Royston TAN (65) 6321 3086 [email protected] Head of Custom Products Group Oil and Gas; Capital Goods Thomas HO (852) 2773 8716 [email protected] David LUM (65) 6329 2102 [email protected] Custom Products Group Property and REITs

Shane GOH (65) 64996546 [email protected] PHILIPPINES Small/Mid Cap (Singapore) Bianca SOLEMA (63) 2 737 3023 [email protected] Jame OSMAN (65) 6321 3092 [email protected] Utilities and Energy Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

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Important Disclosures and Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person.

Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures.

Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Modern Land (China) Co. Ltd (1107 HK); econtext Asia Ltd (1390 HK); Accordia Golf Trust (AGT SP); Hua Hong Semiconductor Ltd (1347 HK); GF Securities Co Ltd (1776 HK); Mirae Asset Life Insurance Co Ltd (085620 KS). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

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Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage.

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There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report.

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Thailand This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”). This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any direct or consequential loss arising from any use of this research or its contents. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user. Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research.

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United Kingdom This research report is produced by Daiwa Capital Markets Europe Limited and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange, Eurex and NYSE Liffe.

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany.

Bahrain This research material is distributed in Bahrain by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (Tel no. 212-612-7000).

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 60.4% Hold** 26.0% Sell*** 13.6% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 30 June 2015. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

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When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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