The China Analyst: Online and Mobile Games Gaining Popularity

Industry Note September 13, 2004 Safa Rashtchy, Senior Research Analyst Technology 650 838-1347, [email protected] The China Analyst: Online And Mobile Games Aaron M. Kessler, Sr Research Analyst 650 838-1434, [email protected] Gaining Popularity

Reason for Report: KEY POINTS: Industry Overview The China Analyst is our weekly report on the Chinese Internet and technology market. Our commentaries are based on data we collect daily in China using our Related Companies: staff and consultants as well as industry contacts in Mainland China and Hong CTRP 31.52 Kong. Our goal is not to summarize news, but to analyze the most important CHINA 6.73 developments in Internet, online games, wireless services, economy, technology, NTES 35.51 SINA 22.23 consumer behavior, corporate activities, and government regulations, and to SOHU 15.13 discuss how these trends impact both our existing coverage companies in China as SNDA 24.19 well as the broader, long-term development of the Chinese Internet market.

Summary of Internet Activity in China (MM) Jun-04 Jan-04 Jun-03 Y/Y % Total active users 87 80 68 28% Dial-up subscribers 52 49 47 11% ISDN subscribers 6 6 5 20% ADSL subscribers 31 17 10 210% Source: China Internet Network Information Center, Piper Jaffray China Research

Summary of Telecom Activity in China (MM) Jul-04 Jun-04 Jul-03 M/M % Y/Y % Fixed line subscribers 299 295 241 1.4% 24% Penetration rate 24% 24% 19% - - Mobile users 310 305 239 1.6% 30% Penetration rate 24% 24% 18% - -

Source: Ministry of Information Industry of China, Piper Jaffray China Research

Industry Commentary – Online and Mobile Games Gaining Popularity as more companies are focusing on this fast growing, and relatively safe, segment. Industry News - Olympics benefits Sina, eBay to integrate Eachnet, etc. China Stocks This Week - Update on company performance. Company Updates - Our latest thoughts on Sina, Sohu, NetEase, Ctrip, and Shanda.

Piper Jaffray China Internet Index (PJCII) Index Last Week YTD LTM Piper Jaffray China Internet Index 5.1% -36.2% -40.7% NASDAQ 2.7% -5.4% 2.6% Risks - Include the volatility of wireless revenues, investor sentiment toward a young and new sector, the potential of government intervention, and the potential of decline or volatility of economic growth. The unique corporate structure of the Chinese Internet companies also poses additional risk factors for investors.

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Industry Commentary Online And Mobile Games Gaining Popularity . The online game sector in China is gaining more respect and popularity from an increasing number of Internet and wireless companies, as well as from U.S. based game companies. In addition to the expansion of the existing titles and game genre, many companies are now focused on developing new mobile games, which we believe will eventually constitute a large opportunity. Several factors are contributing to this trend, in our opinion. First, the continued growth and success of companies like Shanda and NetEase's online game operations have been in sharp contrast with the difficulties faced by the wireless entertainment and services sector. Second, while there has been some crackdown by the government to control the content of the games and ensure that violent and adult material is excluded, the most successful games in China have traditionally avoided these sensitive areas and thus, only minor, gray-market type games were impacted (unlike wireless services, all legal online games must be pre-approved by the government agencies before they are offered even as beta products). Finally, the popularity of the online games has expanded to a wider user base and now includes older users as well as more women, especially as more "casual games" (less intense than the Role Playing games) are developed and marketed.

These trends all bode well for a clear expansion path from online games to mobile games (we note that is not a migration path since the functionality and interface offered by high bandwidth, large screen PCs cannot be duplicated by handheld mobile devices). Many of these games can also be ported to wireless platforms in new formats and titles, and we fully expect that in the next three years, the games segment will constitute a large part of the wireless services revenues. Revenues from wireless games are now negligible, but the operators (China Mobile, China Unicom) as well as service providers and the games developers are highly focused on this segment.

Industry reports suggest that the U.S.-based Electronic Arts is actively looking for investment and/or partnership opportunities in China. Several Japanese and Korean game companies have also stepped up their involvement in China and are now looking to expand into the mobile game sector. Shanda, the leading online games company in China recently announced the acquisition of a small wireless games developer, Digital Red. Separately, KongZhong recently signed a deal with mobile game maker Superscape for distribution of its games through KongZhong's China Mobile platform. We believe most of the wireless service providers will now heavily focus on developing mobile games, both because of the increasing popularity of the games and the availability of the new handsets, as well as the relative stability and safety of these games compared with other types of wireless entertainment content. Unlike IVR, chats, or online dating and friend-finding applications, mobile games don't involve much user generated content. As such, once approved, they are a reasonably safe and stable source of revenue. At the same time, mobile users are getting accustomed to these new forms of entertainment and we believe will be increasingly likely to pay for these games.

Industry News Olympics Benefits Sina . Industry sources report that China's Neilson Netratings has declared Sina the big winner of the online traffic generated by the Athens Olympics. While all portals saw a significant rise in traffic, Sina apparently saw the heaviest the traffic, getting 28 million visitors during the events, from the 13 th to 29 th of August. eBay To Integrate Eachnet . Media reports in China suggest that eBay will finally integrate its Chinese auction site Eachnet into the eBay platform, giving it the eBay look and feel and also requiring eBay registration. The new platform is expected to take effect on Sep. 17th. The registration process may cause some short term drop in listings or closed auctions if all sellers and buyers are required to register as new eBay users. We note that Alibab's auction site Taobao has created fierce competition in China for Eachnet and various industry sources have suggested that Eachnet, in response, has stepped up its advertising spending heavily. Within this context, changes to the platform are particularly important and potentially risky.

Alibaba Expands Its Ad Campaign . Alibaba, the largest B2B network connecting Chinese manufacturers with international exporters, has renewed its ad commitment with CNBC, signing a new contract for nearly $5 million with CNBC, according to industry reports. Alibaba's ads on CNBC show successful U.S. and European business managers who have been able to very efficiently locate Chinese exporters for their products, using Alibaba's network and website. The website allows Chinese business to be listed in a directory that is then searched by businesses worldwide looking for cost-effective producers of a given product. Alibaba also operates the C2C auction site Taobao, referenced above, which competes with eBay's Eachnet in China, and recently announced its intention to invest an additional $42 million in Taobao.

China Stocks This Week. China stocks were mostly higher this week in the absence of any new suspensions and investors getting more comfortable that the major suspensions are behind us. Our China Internet index increased 5.1% last week versus the NASDAQ's 2.7% increase. Year-to-date, the China Index is down 36.2%, while the NASDAQ is down 5.4%. On average, we expect the Chinese stocks to appreciate from current levels as investors become more comfortable with the wireless revenue pattern as well as the heavy sell-off

Customers of Piper Jaffray in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research by visiting piperjaffray.com or can call 800 747-5128 to request a copy of this research. Page 2 of 8 Industry Note September 13, 2004 over the past three months, which has made valuations very attractive, in our opinion.

Year-to-Date Daily Graph Of Piper Jaffray China Internet Index vs. NASDAQ

PJCII NASDAQ 125 120 115 110 105 100 95 90 85 80 75 70 65 60 55 12/31/03 1/23/04 2/13/04 3/08/04 3/29/04 4/20/04 5/11/04 6/02/04 6/24/04 7/16/04 8/06/04 8/27/04

Source: FactSet Company Performance Company Wk/Wk YTD Sina.com 6.7% -34% Sohu.com 6.0% -49% Netease -0.4% -4% Shanda Interactive 11.5% 102% Ctrip.com 1.1% -7%

Company Updates

SINA (SINA, Outperform). Despite the news that one of Sina's IVR services has been temporarily suspended by China Mobile, we don't believe our estimates are at risk as we are at the low end of company guidance. We also note that the company typically gives conservative guidance. An early restatement of the IVR service is likely to be a catalyst for the stock. Based on our market research, we continue to believe that Sina is looking for good strategic acquisitions, which could present a catalyst. We believe Sina is a very attractive, long-term investment with its solid presence in China's Internet market.

Shanda (SNDA, Outperform). Shanda remains one of our top picks in China, with its leading position in online games and now a rapidly expanding portfolio of new games. We believe traction on existing games as well as newly released games should continue to serve as catalysts for shares of Shanda.

NetEase (NTES, Outperform). While NetEase is losing share in the wireless segment, we believe the strength in online games and advertising more than compensates for the weakness in wireless, which now represents less than 20% of revenues. The reduction in wireless revenues, while creating near-term volatility, will actually lower the risk profile for NetEase, in our opinion.

Customers of Piper Jaffray in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research by visiting piperjaffray.com or can call 800 747-5128 to request a copy of this research. Page 4 of 8 Industry Note September 13, 2004 Ctrip (CTRP, Outperform). We would continue to be buyers of the stock as the leading player in the travel consolidation sector in China. We believe Ctrip will continue to exceed our estimates in the coming quarters.

Sohu.com (SOHU, Outperform). We believe Sohu has absorbed most of the impact from its recent MMS sanctions (one-year suspension from China Mobile), and even before this news, was trading at a level that discounted nearly all of the wireless revenues. However, we also believe that Sohu's leverage with China Mobile is at a low point now and will take some time to repair.

Distribution of Ratings/IB Services Firmwide Piper Jaffray IB Serv./Past 12 Mos.

Rating Count Percent Count Percent

BUY [OP] 291 57.51 91 31.27 HOLD [MP] 192 37.94 31 16.15 SELL [UP] 23 4.55 6 26.09

Notes: The boxes on the Rating and Price Target History chart above indicate the date of the Research Note, the rating, and the price target. Each box represents a date on which an analyst made a change to a rating or price target, except for the first box, which may only represent the first Note written during the past three years. Distribution of Ratings/IB Services Firmwide shows the number of companies in each rating category from which Piper Jaffray received compensation for investment banking services within the past 12 months.

Legend: I: Initiation of Coverage D: Discontinuation of Coverage SB: Strong Buy (effective 01/12/04, Equity Research eliminated the SB rating) OP: Outperform (prior to 12/12/01, OP stocks were rated "Buy") MP: Market Perform (prior to 12/12/01, MP stocks were rated "Neutral") UP: Underperform (prior to 12/12/01, UP stocks were rated "Sell") NA: Not Available UR: Under Review SUS: Suspended GP On: Listed on one of the Guided Portfolios maintained by Piper Jaffray GP Off: Removed from the Guided Portfolios maintained by Piper Jaffray

Page 6 of 8 Industry Note September 13, 2004 Important Research Disclosures Analyst Certification — Safa Rashtchy, Senior Research Analyst Analyst Certification — Aaron M. Kessler, Sr Research Analyst The views expressed in this report, including the Key Points and Risk sections in particular, accurately reflect my personal views about the subject company and the subject security. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report.

Research Disclosures Piper Jaffray was making a market in the securities of Ctrip.com International, Ltd. at the time this research report was published. Piper Jaffray will buy and sell Ctrip.com International, Ltd. securities on a principal basis. Piper Jaffray has received compensation for investment banking services from Ctrip.com International, Ltd. within the past 12 months. Within the past 12 months, Piper Jaffray was a managing underwriter of an offering of, or dealer manager of a tender offer for, the securities of Ctrip.com International, Ltd. or the securities of an affiliate. Piper Jaffray was making a market in the securities of NetEase.com, Inc. at the time this research report was published. Piper Jaffray will buy and sell NetEase.com, Inc. securities on a principal basis. Piper Jaffray was making a market in the securities of SINA Corporation at the time this research report was published. Piper Jaffray will buy and sell SINA Corporation securities on a principal basis. Piper Jaffray was making a market in the securities of Sohu.com Inc. at the time this research report was published. Piper Jaffray will buy and sell Sohu.com Inc. securities on a principal basis. Piper Jaffray was making a market in the securities of Shanda Interactive Entertainment Limited at the time this research report was published. Piper Jaffray will buy and sell Shanda Interactive Entertainment Limited securities on a principal basis. Piper Jaffray has received compensation for investment banking services from Shanda Interactive Entertainment Limited within the past 12 months. Within the past 12 months, Piper Jaffray was a managing underwriter of an offering of, or dealer manager of a tender offer for, the securities of Shanda Interactive Entertainment Limited or the securities of an affiliate. Piper Jaffray was making a market in the securities of Yahoo! Inc. at the time this research report was published. Piper Jaffray will buy and sell Yahoo! Inc. securities on a principal basis. Piper Jaffray was making a market in the securities of Amazon.com, Inc. at the time this research report was published. Piper Jaffray will buy and sell Amazon.com, Inc. securities on a principal basis. Piper Jaffray was making a market in the securities of eBay Inc. at the time this research report was published. Piper Jaffray will buy and sell eBay Inc. securities on a principal basis. Piper Jaffray was making a market in the securities of Google Inc. at the time this research report was published. Piper Jaffray will buy and sell Google Inc. securities on a principal basis. Piper Jaffray was making a market in the securities of Electronic Arts Inc. at the time this research report was published. Piper Jaffray will buy and sell Electronic Arts Inc. securities on a principal basis. Piper Jaffray has received compensation for non-investment banking securities-related services from Electronic Arts Inc. within the past 12 months. Piper Jaffray was making a market in the securities of Motorola, Inc. at the time this research report was published. Piper Jaffray will buy and sell Motorola, Inc. securities on a principal basis.

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Rating Definitions Investment Opinion: Investment opinions are based on each stock's return potential relative to broader market indices*, not on an absolute return. • Outperform (OP): Expected to outperform the relevant broader market index over the next 12 months. • Market Perform (MP): Expected to perform in line with the relevant broader market index over the next 12 months. • Underperform (UP): Expected to underperform the relevant broader market index over the next 12 months. • Suspended (SUS): No active analyst coverage, however coverage expected to resume. * Russell 2000 and S&P 500 • Volatility Rating: Our focus on growth companies implies that the stocks we recommend are typically more volatile than the overall stock market. We are not recommending the "suitability" of a particular stock for an individual investor. Rather, it identifies the volatility of a particular stock. • Low: The stock price has moved up or down by more than 10% in a month in fewer than 8 of the past 24 months. • Medium: The stock price has moved up or down by more than 20% in a month in fewer than 8 of the past 24 months. • High: The stock price has moved up or down by more than 20% in a month in at least 8 of the past 24 months. All IPO stocks automatically get this volatility rating for the first 12 months of trading.

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Disclaimers

This material regarding the subject company is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides.

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