Deutsche Bank Markets Research

Industry Date 5 December 2015 China Internet Asia China Technology Software & Services

Alan Hellawell III Research Analyst (+852) 2203 6240 [email protected]

F.I.T.T. for investors

Digital ad exchanges: quietly promoting industry winners

Advertising: it still makes the world go round

While the Chinese Internet economy has gradually shifted away from its initial dependence on digital advertising, the “Big Three” are in fact increasing their reliance upon advertising. Alibaba could provide the most upside surprise in this area. By 2017, we expect Tencent to derive ~34% of total revenues from advertising (up from 15% in 1H 2015). “Marketing Services” meanwhile will constitute roughly 53% of Alibaba's CY2017 revenues, while Baidu will continue to look to search and other ad formats for nearly all of its revenues. As the market's first exhaustive series on Tencent, Alibaba and Baidu's ad business, our first installment focuses on the three leaders' ad exchanges.

______Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015.

Deutsche Bank Markets Research

Asia Industry Date China 5 December 2015 Technology China Internet Software & Services FITT Research

Alan Hellawell III Research Analyst Digital ad exchanges: quietly (+852) 2203 6240 [email protected] promoting industry winners

Advertising: it still makes the world go round Key Changes While the Chinese Internet economy has gradually shifted away from its initial Company Target Price Rating

dependence on digital advertising, the “Big Three” are in fact increasing their BABA.N 98.00 to - reliance upon advertising. Alibaba could provide the most upside surprise in 99.00(USD) this area. By 2017, we expect Tencent to derive ~34% of total revenues from Source: Deutsche Bank advertising (up from 15% in 1H 2015). “Marketing Services” meanwhile will constitute roughly 53% of Alibaba's CY2017 revenues, while Baidu will Top picks continue to look to search and other ad formats for nearly all of its revenues. Tencent (0700.HK),HKD151.00 Buy As the market's first exhaustive series on Tencent, Alibaba and Baidu's ad Alibaba (BABA.N),USD82.59 Buy business, our first installment focuses on the three leaders' ad exchanges. Source: Deutsche Bank

2016: expecting shifting sands across China’s main ad form factors Companies Featured Despite the cooling economy, digital advertising spending in China should see solid 30% growth in 2016 per iResearch. While we concur with iResearch Tencent (0700.HK),HKD151.00 Buy projections of strong mobile (82%), e-commerce (36%), and video ads growth 2014A 2015E 2016E (39%), our sampling of brand owners and ad agencies suggests a weakening P/E (x) 35.6 37.0 28.1 in search spend (DBe Baidu 2016 core search +20% YoY ex-Qunar), largely due EV/EBITDA (x) 21.8 22.7 16.9 Price/book (x) 10.3 10.7 8.0 to an ever growing focus on e-commerce, industry consolidation and the rise of rival mobile P4P products. Baidu (BIDU.OQ),USD207.48 Hold What is the most important core competence of the Big 3? Ad technology 2014A 2015E 2016E While the Chinese internet economy is driven by e-commerce transactions, P/E (x) 29.6 36.5 28.6 social networking, gaming and other activities, it will be the sophistication of EV/EBITDA (x) 23.1 31.0 25.0 Price/book (x) 9.5 7.1 5.6 the ad technologies of Tencent, Alibaba and Baidu (aka “TAB”) that will separate successful companies from less successful over the next five years. In Alibaba (BABA.N),USD82.59 Buy this first installment of our digital ads series, we evaluate each of these three 2015A 2016E 2017E platforms’ advertising exchanges as proxies for their advertising prowess and P/E (x) 46.0 31.5 23.3 ability to attract customer spend. Tencent should see strong growth in mobile EV/EBITDA (x) 52.5 32.6 20.0 ad revs. We, however, believe Alibaba has the greatest capacity to surprise Price/book (x) 8.6 5.6 4.6 investors with its “Super-ID” capabilities and unrivaled “omni-channel” ability Source: Deutsche Bank to follow the user across internet properties and devices – a feature most in- demand amongst advertisers that we interviewed. Our findings around China’s three main ad exchanges firmly support our Buy recommendation on Alibaba. The ad exchange: a showcase for TAB ad technology prowess It is not surprising that China’s three dominant platforms have achieved a similarly commanding role in digital advertising. Each now offers its own ad exchange, a fully automated clearing house which dynamically matches demand from advertisers with ad inventory from website owners. We appreciate Tencent’s rising dominance of two of the four advertising “mega- trends” profiled herein: a) going mobile and b) RTB and programmatic. It is Alibaba’s successful exploitation of omni-channel capabilities that leads us to conclude that its Alimama ad group will continue to dominate. Valuation methodologies largely earnings-based Tencent TP of HK$173 based on SoTP: 1) 15x FY15E PE for online game + VAS; 2) 1.1x PEG for mobile games; 3) 1.2x PEG for ads. US$99 Alibaba TP involves CY16E non-GAAP PER (50% weighting), CY16E EV/EBITDA (30%), and 20% DCF. Baidu TP of US$189 based on PEG of 1.0x against FY16-18E EPS CAGR. Upside/downside risks: pace of mobile properties monetization. industry competition, trends in user activity.

______Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015.

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Table Of Contents

2016 outlook for ad budgets ...... 3 Key highlights ...... 3 The DB survey: Robust 2016 growth in most areas of ad spend ...... 3 Major trends from the DB survey ...... 4 The importance of ads ...... 5 The ad exchange: behind-the-scenes enabler ...... 8 Key highlights ...... 8 The ad exchange – an unseen battle on the China internet ...... 8 Measuring the benefits of exchange, programmatic and RTB ...... 9 The economics of the exchange ...... 12 The market & its likely success stories...... 16 Key highlights ...... 16 China and Rest-of-World: different competitive landscapes...... 16 China’s three great ad exchanges ...... 16 DB’s four mega-trends: how TAB stack up ...... 17 Ad exchange “mega-trends” ...... 20 Four critical developments in China’s ad exchanges ...... 20 Mega trend 1: Programmatic buying and RTB ...... 20 Mega trend 2: Ad exchanges go mobile ...... 23 Mega trend 3: Ad exchanges go omni-channel ...... 27 Mega trend 4: Ad technology consolidation ...... 29 The Tencent GDT ad exchange ...... 32 Tencent GDT: strong in premium, social and mobile inventory ...... 32 The Alimama Ad Network ...... 34 China’s most dominant exchange, leveraging unrivaled big data capabilities . 34 Baidu BES ...... 36 Baidu Exchange Service: strong in ad demand, Baidu Union and video ...... 36 Appendix: Ad exchange basics ...... 38 Public and private exchanges ...... 39 Obstacles to the adoption of the “trifecta” in China ...... 41 Summing it up ...... 43 China internet peer comparison ...... 45

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2016 outlook for ad budgets

Key highlights

 The most significant development in 2016 will be the shift of digital ad budgets to more programmatic and real-time bidding-based purchasing.

 Ad agencies and brand advertisers view “going e-commerce” as a key 2016 strategy.

 Search ads growth likely to weaken in 2016

 Pace of relaxation of advertiser access to Weixin is pivotal to Tencent quickly growing scale. The DB survey: Robust 2016 growth in most areas of ad spend

Brand owner, agency feedback suggests more moderate 25-27% growth in 2016 In the run-up to finalizing this report, we interviewed no less than 25 brand owners and digital advertising agencies regarding their 2016 investment plans across the Chinese digital landscape. While some large MNC accounts interviewed have planned minimal growth (10-20%) in digital ad budgets in 2016, feedback from the eight-or-so digital ad agencies pointed to more constructive growth trends (25-27%), albeit slightly less growth than the 30% YoY increase that iResearch has forecast below.

Figure 1: China online advertising growth still strong in 2016

450 RMB bn 45% 42% 400 40% 40% 350 36% 393.0 35% 300 30% 332.7 30%

250 272.4 25% 22% 200 20% 209.3 18% 150 15% 154.0 100 10% 110.0 50 5% 0 0% 2013 2014 2015E 2016E 2017E 2018E

Total online ad revenue size YoY

Source: iResearch

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Major trends from the DB survey

Biggest 2016 trend: continued growth in programmatic buying and RTB Several ad agencies, ad tech companies and brand owners themselves expect one of the most significant developments next year to be a shift of digital ad budgets away from “plain vanilla buys” to more programmatic buying and real-time bidding-based purchasing (these two terms explained herein). We have thus chosen China’s ad exchanges (which host the programmatic and RTB buying of digital ads) as our main focus of this first report.

“Going e-commerce” in 2016: Alibaba, JD to benefit Among other salient predictions for 2016, nearly every single ad agency and brand owner respondent described “going e-commerce” as a key strategy next year, meaning that they are more aggressively developing strategies to more directly reach and sell to the customer on-line. At the heart of these strategies is building a larger presence on leading e-commerce platforms such as Tmall, JD and Vipshop. One of China’s largest digital ad agencies in fact went so far as to describe Alibaba’s search and display business as going “from strength to strength” as China’s most heavily trafficked e-commerce marketplace with some of the most efficient tools to access the customer.

Search growth likely to weaken amongst key accounts, although SME spend robust Nearly all of the brands that we interviewed meanwhile claim either to be Baidu reigns in the holding flat YoY their general search spend on platforms such as Baidu and Qihoo, or even paring it back. Several accounts mentioned diminished efficacy advertising market with and track-ability of search on mobile relative to desktop, and the growing 33% market share attraction of rival P4P (pay-for-performance) ad formats such as those offered by Tencent. The search product offered on Alibaba was generally viewed as more targeted and offering higher RoI (return on investment) over general search keyword purchase.

China large brand and SME importance to online advertising is growing Many of those interviewed in our survey manage budgets in excess of USD100m per annum. Our survey was skewed toward multi-national brands. We believe that MNC’s are now only 13% of total China digital advertising. We moreover estimate in the case of search that large accounts likely represent only 25% of Baidu’s search revenues. The feedback above leads us to maintain our revenue growth expectation for the search leader to 26% YoY (after deconsolidating Qunar), versus an iResearch full-market search forecast of 35% YoY in 2016. It is possible however that SME demand for search may well be growing measurably faster according to discussions with players in the ad tech space. A vast majority of Baidu’s 623,000 active customers (as of the third quarter) were SME’s.

Mobile – 2016 possibly still a wait-and-see year; Weixin plans crucial While every single participant in our survey indicated that mobile budget would grow strongly (please also note iResearch forecasts below), many cited a myriad of technical challenges around inventory, tracking and delivery as preventing even more aggressive spend in this space. As one of the most sought after forms of mobile advertising, Weixin will play a pivotal role in the growth curve. What remains uncertain is Tencent’s eagerness, and wherewithal, to increase “ad loads” on properties such as the Weixin Moments feed. Vigilant protection of “user experience” could for instance lead

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to a much more gradual build in this form of mobile P4P advertising. The company meanwhile will need to further automate advertising on these key properties, develop much deeper distribution channels to SME’s and undertake various other steps that US peer, Facebook took to build an advertiser account base of over 2.2m.

Figure 2: Mobile to become bigger driver of total online advertising growth

250 RMB bn 160% 151% 200 122% 120% 105% 150 82% 80% 100 49% 56% 50% 41% 40% 50 29% 33% 19% 12%13.4 29.7 61.0 111.1 165.5 220.1 0 0% 2013 2014 2015E 2016E 2017E 2018E

Mobile advertising revenue YoY % As % of total online advertising

Source: iResearch

While mobile P4P ad form factors are set to grow strongly going forward, other more mature types of advertising, such as banner ads, text links and rich media, will likely see further deceleration in 2016.

The importance of ads

The largest players in China online advertising As the figure below illustrates, Baidu captured more than one-third of China 1H 2015 online ad revenues, followed by Alibaba (21%). Tencent meanwhile grew ad revs the fastest of the big three (+110% YoY).

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Figure 3: China top 10 online advertising publishers by ads revenue (1H15)

Market share

33% Baidu 29.2

21% Alibaba 18.8

7% Tencent 6.1

4% Qihoo 360 3.3

4% Sohu 3.3

4% Google China 3.1

2% Youku Tudou 2.2

2% Sina 2.1

2% iQiyi 1.8 RMB bn 2% Qunar 1.5

0.0 10.0 20.0 30.0 40.0 Source: iResearch

We present a snapshot of China’s 10 largest listed internet companies, and the extent to which they rely on online advertising.

Figure 4: China’s 10 largest listed internet companies and their advertising revenue contribution 1H15

100% 98% 90% 80% 70% 66% 64% 59% 60% 48% 50% 40% 30% 20% 15% 9% 10% 1% 1% 1% 0%

Source: company data Note: Ctrip display ads rev is based on

Advertising is critical to the future of TAB As we show below, advertising is an important part of each of the big three platform’s business, and will remain so going forward.

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Figure 5: TAB’s total revenue from advertising RMB mn 2012 2013 2014 2015E 2016E 2017E 2012-2017E 2015-2017E CAGR CAGR Tencent 3,382 5,034 8,308 17,396 32,113 54,993 75% 78% Alibaba (adj for CY) 18,143 28,366 37,833 46,786 63,902 88,249 37% 37% Baidu 22,306 31,944 49,052 66,129 80,473 99,231 35% 22% Ads revenue as % of total revenue Tencent 8% 8% 11% 17% 25% 34% Alibaba (adj for CY) 59% 59% 54% 51% 51% 53% Baidu 99% 99% 96% 96% 95% 95% Source: Deutsche Bank estimates, company data

While the ad business is growing robustly for all three players, we think Tencent, largely through monetizing its near-ubiquitous mobile platforms Weixin and Mobile QQ, is likely to boast the highest FY15-17E growth momentum with a CAGR of 78%. Alibaba, meanwhile, should preserve its past 3-year growth CAGR of 37% between FY15E and FY17E as it continuously layers in new ad formats and improves the efficacy of existing ones. The tighter incorporation of important non-Taobao resources, such as UCweb and Youku Mobile, should aid this growth. Baidu is still highly geared to search ads and will likely see a gradual decline in ad growth in the following years.

The figure below specifically reveals how rapidly Tencent will grow scale to rival that of its two peers. We expect Tencent’s advertising scale to achieve around 50% that of Alibaba by 2016E and 62% by 2017E.

Figure 6: T.A.B’s advertising revenue growth

120,000 RMB m 100,000

80,000

60,000

40,000

20,000

- 2012 2013 2014 2015 2016 2017

Tencent Alibaba (adj for CY) Baidu

Source: Deutsche Bank estimates, company data

Having illustrated the centrality of advertising to each of China’s three dominant platforms, we seek herein to evaluate each company’s’ wherewithal to dominate China’s digital ad market by assessing their strengths in ad exchange and ability to accommodate the market’s rapid shift to programmatic buying and real-time bidding (RTB)

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The ad exchange: behind- the-scenes enabler

Key highlights An Ad exchange is a  Ad exchanges have risen to become increasingly important clearing clearing house for the houses for digital ads buying on the internet. A substantial 28% of China digital display spend is expected to occur on exchanges by 2017. purchase of digital ads

 Ad exchanges play a central role in the buying and selling of ad inventory on the internet in on both RTB (real-time bidding) and non-RTB programmatic basis. markets such as US and  One of the most profound contributions that the ad exchange brings is its Europe. ability to “open up the long tail” ad inventory. The ad exchange – an unseen battle on the China internet

Ad exchange: the elusive enabler, to represent 28% of China digital display ad spend by 2017 One of the most dramatic transitions likely to set in across the Chinese internet is the adoption of exchange-based digital ad spend. eMarketer for instance expects total programmatic and RTB spend to grow to RMB28.3b by 2017, representing 28% of total display ad spend, and 9.4% of total digital ad spend. iResearch similarly expects 24% of display ad spend and 8.5% of total digital ad spend to flow over ad exchanges by 2017. Programmatic and real-time bidding (RTB) are the two main means of buying ad placements on an ad exchange. We explain these two processes in greater detail below.

What is this powerful enabler, the ad exchange? The ad exchange can only be seen by the trained eye. Most advertisers have never interacted directly with an ad exchange. The ad exchange is instead a code that sits deep in the bowels of the internet enabling a wide range of digital ad spend to occur. These ad exchanges have risen to become increasingly important clearing houses for digital ad buying on the internet in other markets such as the US and Europe.

Opening up a Pandora’s Box of complexity We present below a massively simplified depiction of the ad exchange and its component technologies and processes. We deliberately overlook a tremendous amount of complexity in order to drive home simpler, but key, concepts necessary to understanding the future of China’s largest internet properties.

We show the evolution toward ad exchange in its simplest form below. The figure shows the transition from direct buying and selling of ad inventories (the somewhat chaotic, inefficient and opaque marketplace on the leftt hand side) to a system involving an ad exchange on the right. The ad exchange plays a central role as an intermediary in the buying and selling of ad inventory on both an RTB (real-time bidding) and non-RTB programmatic basis. Again, we promise to explain these terms later.

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Figure 7: From direct buying to ad exchanges

BEFORE TODAY DIRECT BUYING & SELLING THE AD EXCHANGE PUBLISHER ADVERTISER ADVERTISER PUBLISHER

PUBLISHER RTB AD ADVERTISER PUBLISHER ADVERTISER SOLUTION EXCHANGE

PUBLISHER

ADVERTISER ADVERTISER PUBLISHER PUBLISHER

ADVERTISER PUBLISHER ADVERTISER PUBLISHER

Source: Deutsche Bank

Ad exchanges are most often used to sell display, video, and mobile ad inventory. The first ad exchange, launched by Google Doubleclick in 2009, offered a totally automated alternative to the often laborious, inefficient and non-transparent buying and selling of ads previously undertaken by offline ad salespeople, brokers, etc.

Measuring the benefits of exchange, programmatic and RTB

More on how the ad exchange works (Please refer to the Appendix section for greater detail on core concepts)

Ad technology, while being the lifeblood of monetization of much of the internet, is an extremely complex area to study. We furnish below a collection of definitions of the main constituent pieces of a properly functioning ad exchange. “The trifecta”: the ad exchange + programmatic buying + real-time bidding This report has been more than half a year in the making. The first five months alone were spent trying to make our way through a seemingly endless labyrinth of technologies, architectures and acronyms. The ad technology space is mind-numbingly complex. We would urge our readers to refrain from focusing on anything but our top-line takeaway’s, lest they drown in any number of extremely confusing constructs.

What you need to know – the three main concepts There are three complimentary concepts that are growing in the Chinese digital ads market simultaneously, the basics of which are necessary to master in our minds. While we touched upon each concept briefly earlier in this report, in this section we explain in greater detail these building blocks:

 Ad exchange

 Real-time bidding (RTB)

 Programmatic buying

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What is an ad exchange? An ad exchange, very simply put, is a digital marketplace that enables advertisers and publishers to buy and sell advertising space in an automated fashion. It replaces a lot of the direct buying and selling of ads that has occurred since the mid-1990’s. Ad exchange-based transactions occur through:

 real-time bidding (RTB), by which ads are bought and sold by real- time matching, much in the same way a stock market works.

 non-auction-based programmatic purchase (with the advertiser buying ad space by agreeing in advance on pricing with the publisher.)

RTB: turning the offline digital ad marketplace into a stock market We have illustrated in some amount of detail how an exchange works earlier in this report. Real-time bidding is the means by which advertising inventory is bought and sold on a per-impression basis, via instantaneous auction, on an ad exchange. RTB’s greatest innovations are:

 the ability to place up for sale any ad slot opportunity on any website that is connected to an exchange. With the advent of RTB, billions of previously inaccessible, long-tail ad slots can be filled, satisfying publishers by giving them completely new, previously-untapped revenue sources on one hand, and offering access to totally new advertising inventory to advertisers.

 the ability to set an efficient price for an available ad slot, given the auction-based approach by which it is sold

 an improved ability for advertisers to measure and compare metrics such as RoI across a wide range of ad formats, across competing publishers, etc. Publishers similarly can decide dynamically what inventory to open up for sale, through which exchange to sell, etc. Programmatic buying: an automated “block trade” arranged outside of the RTB “stock market” Many website owners are loath to place their more valuable inventory on an RTB exchange, lest the auction environment rob them of their ability to control and protect their premium pricing. Many advertisers conversely are willing to pay a distinct premium for access to higher quality, more exclusive inventory. Non-RTB programmatic buying largely exists to enable the same level of automation of RTB-based buying, but without subjecting the transaction to an open bidding process.

One way to look at programmatic versus RTB: “Wang’s pyramid” Advertisers and publishers tend to view RTB as being at the far end of the spectrum of alternatives when compared to the more refined forms of programmatic buying. Charlie Wang, former Mindshare China digital lead and COO of leading programmatic advertising start-up Reach Max, has kindly granted us permission to feature his “Programmatic Trading Pyramid” below. The figure shows at the bottom of the pyramid “open exchange-based” buying options such as real-time bidding. Ads sold on an RTB basis tend to be the remnant inventory of a website that the publisher does view as price-sensitive, and is thus willing to put up for auction. With most of these ad slots representing the less premium parts of the publisher’s inventory, RTB often

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tends to carry a low CPM (see bottom right of figure.) RTB-based ads, given the transparent way in which they are priced, can often carry an attractive RoI for some types of advertisers. The following chart compares these advertising purchase methods.

Figure 8: Programmatic Trading Pyramid

Inventory Price

Reserved Direct Sales Programmatic Premium Fixed Premium High CPM

Preferred Deal

Private Marketplace

Unreserved Auction Remnant Open Exchange, RTB Low CPM

Source: Deutsche Bank; Charles B Wang

RTB – unreserved, remnant inventory preferred by performance advertisers As the perceived value of the inventory grows, the publisher tends to be more reluctant to put the inventory up for open auction, and instead prefers to extend preferred deals to willing advertisers. Performance oriented clients usually are very results driven, KPIs quantifiable by outcomes such as actions, sales, and leads. These types of clients are largely pure online businesses, such as e-commerce sites, game apps, or small to medium-sized businesses (SMB).

Programmatic premium, preferred deal – best for brand advertisers As Mr. Wang writes, for many of China’s branding clients – such as FMCG, food and beverage – business outcomes actually happen offline. Their digital campaigns thus cannot be very outcome-driven. Instead, they will focus on reaching as many target audiences as possible in the hope of an offline sales conversion. In this case, it is important to keep a guaranteed access to high quality media channels, so programmatic premium is the most suitable trading model.

The ad exchange in action: an example The entire auction process starts with a user’s visit. When a user for instance:

 reaches a portal or some other website (e.g. www.sina.com)

 opens up an advertiser-supported mobile app

 begins to watch a show on a video client …any available ad slots call upon an ad server, and thus an ad request is made to the ad exchange to sell the ad slot. If a programmatic purchase has already been made on the ad slot, it gets filled on a pre-ordained basis. If the ad exchange instead is selling it on a real-time bidding basis, it will then allow advertisers to bid for the impression. Advertisers on the exchange apply for this “auction”. The ad exchange reviews all bids, filters for those that could match specific requests, and measures the likelihood of conversion. The exchange then chooses the winner, who offers the highest bid , e.g. the highest

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cost per action (CPA), cost per click (CPC), cost per thousand impressions (CPM). The ad will then present on the ad slot to the user.

We present below a highly simplified graphic of how an advertiser buys through an exchange. Please refer to our Appendix “Ad exchange basics” for a discussion of DSP, SSP, etc.

Figure 9: Major parties involved in the ad exchange

Advertiser Publisher

DSP Ad Exchange SSP Target Audience

Ad network Ad network

DMP DMP

Source: Deutsche Bank

The economics of the exchange

Public exchanges tend to capture a 15-30% take-rate Public exchanges tend to Ad exchanges generally put up an ad slot for auction, and award the ad slot to capture a 15-30% take rate the highest bidder in the case of real-time bidding. The proceeds of the auction are generally split between the platform (the exchange) and the publisher on whose site the ad was just run. The ad exchange tends to take at least 15% by acting as a “supply-side platform” (“SSP”) to the publisher by sourcing demand, and it can take an additional 15% should the advertiser use the exchange’s own demand-side platform (DSP). Given that there are many third party DSP’s in the marketplace, the exchange often does not capture the 15% DSP-related fee. In the case of (non-RTB) programmatic buying, similar economics apply despite there being a fixed price and no auction.

Public exchanges take as little as 0% if the publisher is highly sought after The revenue share ratio can differ substantially among different channels and publishers. Some of our channel checks for instance indicate that some mobile premium inventory owners can claim as high as 100% of the ad spend, with the ad exchange thus getting nothing. Long tail inventory owners on the other hand can get much less. We compare the cut that the exchange takes between premium and non-premium inventory below.

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Figure 10: Ad exchange take rates generally range from 15% to 30%

exchange takes 15% Advertiser Publisher DSP Ad Exchange SSP

Premium Advertiser publisher

Source: Deutsche Bank

Private exchanges capture most/all of the economics In the case of a private exchange such as Tencent’s GDT, given that Tencent owns the inventory, it does not need to share the economics with anyone in most cases. The company however does share revenues in two particular instances that we know of: a) with certified owners of user generated content (UGC) and producers of PGC (professionally generated content) on its video sites, and b) with the owners of those Weixin official account ads on which Tencent places advertisements. Tencent originally passed all public account ad revenues to the owners of the public accounts. We believe that it now only shares 55%.

How the big platforms book revenue: gross versus net Of the three big platforms, Alibaba and Baidu place ads both on their own properties and on third party websites and portals. In the case of Tencent, most ad placement occurs within its own walled garden.

 Tencent effectively reports all ad revenues generated on its own properties on a gross basis.

 Alibaba has two major programs related to its TANX exchange:

 The Tao Affiliate program: By selling ad slots on third party websites to both Taobao/Tmall merchants and third party advertisers, Alibaba tends to charge on a CPC (cost per click) or CPM (cost per mille) basis. Alibaba pays out a percentage of gross ad revenues (50-70%) to third-party websites through this program.

 The Taobaoke program: Alibaba also charges on a CPS (cost per sales) basis as part of its Taobaoke program. The advertiser is a Taobao or Tmall merchant, and will pay roughly 10% from the sale resulting from a click to Alibaba. Alibaba in turn tends to pass 90% of that amount to the external publisher website. Alibaba books this business on a net basis, given that it often only captures 1% of the transaction as an advertising fee.

 Baidu, adopts the gross method for Baidu Union, and on average shares 40-60% of revenues with third-party websites.

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The downside of public ad exchange-based revenues: gross margin profile. Tencent with the best margin as private exchange While we regard growth in the public ad exchange businesses as largely incremental to company revenues, the gross margin profile of ad revenues booked on public exchanges can weigh on corporate margins, particularly in the case of Alibaba. We have forecast a FY2016 gross margin of 69% for Alibaba, which would indeed be negatively impacted by outsized growth from its TANX business, given that TANX shares anywhere from 50-70% of its ads proceeds with publishers and other partners. Baidu, with a DB 2016 gross margin forecast of 62%, could also see margin compression with the strong growth of its BES business. Tencent nicely shares very few revenues as mentioned above, as it operates more as a private exchange.

Why dominate in exchange? Be like Google Despite the lower margin profile of this business, we would again emphasize that: a) the ad exchange business represents incremental revenue to all three players and b) dominance in ad exchange would also be indicative of broader dominance and valuable leverage in China’s digital ads industry. We believe that Google’s unrivaled leadership in ad exchange is a core component of its broader leadership in the overall digital ads industry.

Google’s ad exchange-based revenues, however, are indeed of a lower margin profile than much of the rest of its business. Looking at the company’s September quarter results, we note that Google derived USD3.7b, or roughly 20% of its revenues, from DoubleClick and other “Network” activities. Traffic acquisition costs of USD2.5b in the quarter represented a 68% revenue share for “Network” ad exchange revenues. Google’s broader COGS in the third quarter however was 38%.

Bringing advertising to the long tail One of the most profound contributions that the ad exchange brings to digital advertising is its ability to “open up the long tail” amongst both publishers and advertisers.

 Benefit to publisher: increase inventory fill rate, increase revenue. By connecting through API (application programming interface) to an ad exchange, any medium or small-sized publisher can suddenly host advertisements on its website and create a new revenue streams to maintain and expand its business. Several publishers whom we interviewed have seen a 15% bump to revenues by selling “remnant inventory” to an exchange.

 Benefit to advertiser: better access to advertising opportunities, improved targeting, and improved conversion. The whole process of automating the ad buy on an exchange opens up new ad opportunities, improves trackability etc for all advertisers, big and small. Local SME’s and small brands moreover that lack the scale to work with a digital ad agency can link directly to an ad exchange and begin promoting their business on the web. Much of the advertising eco-system has historically existed to serve the interests of larger players. On the publishing side, large websites to this day rely little upon ad exchanges and moreover may be unlikely to expand their placements with them in the future, as their sales teams can do millions of dollars of sales by working directly with large brand owners and ad agencies. We estimate that Top 50 websites such as Sina, Sohu, Phoenix New Media, Autohome and others place less than 10% of their inventory on exchanges.

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In this report, we seek to explain the evolution and basic workings of the ad exchange, an admittedly daunting task given the countless and complex constituent technologies (please see our extended Appendix A for detail on how ad exchanges work, technology definitions, market sizing, etc). We more importantly seek to evaluate the prospects of Tencent, Alibaba and Baidu in succeeding as ad exchanges, and in turn their prospects in dominating the broader digital ads landscape in China.

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The market & its likely success stories

Key highlights Google rules the world, but

 China’s digital ads landscape is highly fragmented and complicated. not China…

 The market understands Tencent as China’s leader in ad exchange-based growth, driven largely by ever-improving targeting and connectivity to mobile platforms Weixin and Mobile QQ.

 We, however, view Alibaba as the player capable of delivering the greatest upside surprise as it rolls out omni-channel targeting and more fully monetizes mobile. China and Rest-of-World: different competitive landscapes

Whereas Google reigns supreme as the leading ad exchange outside of China… Google is absolutely and undisputedly the world’s dominant ad exchange, specifically through its Doubleclick platform and accompanying tools. We attribute much of Google’s status as the world’s largest internet company to the unrivaled ad technologies that the company has cultivated over the years, not just in search but also in areas such as ad exchange.

…China’s digital ads landscape meanwhile is highly fragmented While the more developed markets that Google serves have had several years to evolve into highly specialized and efficient industry structures, in the Chinese context, much of the digital advertising landscape remains highly fractured, complicated by multiple participating players with different and competing roles and duties.

China’s three great ad exchanges

An introduction to the big three players and their ad exchanges Not surprisingly, China’s three mega-platforms are behind the market’s three largest ad exchange efforts:

 Alibaba has its Alimama Ad Network and in 2011 incorporated its TANX exchange.

 Baidu has developed its BES (Baidu Exchange Service)

 Tencent has focused increasing effort on its GDT (Guangdiantong exchange) The competitive share gains that Tencent, Alibaba and Baidu make against each other as they each seek to cross ever-larger amounts of digital ad supply and demand on their respective exchanges, will reveal who is becoming dominant in crucial areas such as advertising technology, access to ad inventory and gains in advertisers wallet share.

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T, A, and B approach exchange differently China’s largest three internet companies have focused on three different areas historically, i.e. gaming and social (Tencent), e-commerce (Alibaba), and search (Baidu). Each hence has established its own unique value proposition and strengths on top of these unique foundations:

Tencent  Tencent is dominant in mobile as the owner of China’s largest mobile social networks, Mobile QQ and Weixin.

 The “social cues” for instance that its users offer by sharing postings, liking and commenting on them etc, can improve ad targeting efficiency (e.g.-if I like a certain product, my friend or broader peer set, may also like it).

 Of the three major local exchanges, Tencent is the player making the greatest progress in advertising monetization currently, given an historic focus in other areas such as gaming and social.

 The company, moreove,r is sitting on some of the China mobile internet’s most premium inventory (e.g. Weixin Moments) yet has been cautious in offering much inventory out to advertisers. Alibaba  Alibaba, as China’s first and largest exchange, currently dominates areas such as programmatic trading and real-time bidding, despite Tencent’s major gains in this area. The Alibaba TANX exchange for instance is connected to the largest number of publishers in China.

 Alibaba’s focus on e-commerce moreover presents advertisers with traffic having that tends to have higher commercial intent.

 We view the broader Alimama Ad Network as China’s innovator in the application of big data to gain ever greater insight into the user and thus improve targeting. We also note that Alibaba’s “Dharma Sword” effort seeks to offer the best ad placement in an “omni-channel” world, in which advertisers seek to target consumers across smartphone, PC and tablet. Baidu  As China’s largest search engine, Baidu has historically been China’s leader in pay-for-performance (P4P) advertising.

 The company, moreover, maintains one of China’s widest networks of SME and large advertisers (by last count, the company in one quarter had 623,000 paying advertisers), in addition to boasting connectivity with hundreds of thousands of website-publishers (through Baidu Union, etc.)

 Baidu seems specifically well positioned in video programmatic buying. iQiyi ad inventory for instance is gradually being connected to the BES exchange system.

DB’s four mega-trends: how TAB stack up Alibaba is China’s unheralded leader in ad What does an ad exchange require to succeed? An ad exchange requires several characteristics to succeed. The most exchange important capabilities include:

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 A robust programmatic and RTB-based buying solution. Necessary in offering these forms of digital ad buying is mastery in the many component ad technologies (DSP, SSP, DMP, etc), all of which we explain in an earlier section. These various forms of functionality are crucial to support the basic value proposition of an ad exchange.

 Very detailed data on the user in order to support a highly targeted ad experience. A platform enjoys better insights into user behavior if for instance the user is “logged in” during his visit. Being able to record activity across multiple properties moreover adds greatly to the depth and breadth of user data.

 Similar to the above, the ability to offer a service across multiple devices (PC, notebook, smartphone, tablet, etc) and track an audience across these devices is also important.

 A specific expertise in offering mobile ad exchange. With so much of user behavior having gone mobile, and more to come, an advertiser will require a robust solution to target these users, and just as importantly measure the effectiveness (RoI) in advertising to them in the mobile environment. Ultimately, a successful ad exchange needs to clearly demonstrate value-add to China’s advertisers, favorably answering questions such as: “What is my RoI in working with ad exchange A or B? Which exchange exposes me to the most desirable inventory? Can I follow the user from one device to another, from PC to mobile?”

We view Tencent as the unheralded innovator in ad exchange; Alibaba’s monetization opportunity is, however, least understood While we have articulated above what the basic qualifications are to become a successful ad exchange, far more important in our mind is the ability to dominate the many trends that have beset this extremely dynamic, ever- changing industry.

In the next section, we evaluate the competitive positioning of the big three ad exchanges and those offered by other players, to determine who is best suited to capture China’s digital advertising “mega-trends.” We have identified a leader in each of the four areas as we show below:

 Mega trend 1: Programmatic buying and real-time bidding (RTB.) Leader: Tencent.

 Mega trend 2: Ad exchanges go mobile. Leader: Tencent.

 Mega trend 3: Ad exchanges go omni-channel. Leader: Alibaba

 Mega trend 4: Ad technology consolidates. Leader: Alibaba It’s all about who you know, and where they are… As we reveal above, we expect Tencent to continue to perfect important digital advertising paradigms such as programmatic buying and RTB, while successfully monetizing its absolute dominance in the mobile realm by continuously rolling out new ad form factors across platforms such as Weixin and QQ Mobile. Tencent’s unrivaled dominance in Chinese internet users’ daily life and expertise in areas such as targeting and conversion could translate to much faster overall advertising growth. We, however, believe that Tencent faces measurable execution risk in meeting our already formidable growth

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assumptions. The company will for instance need to expand its distribution channels to connect to the hundreds-of-thousands, if not millions, of advertisers to drive advertising to 1/3 of total revenues by 2017. We instead see upside risks for Alibaba and it has a long runway of monetization.

The survey: brand advertisers indeed preferring Tencent and Alibaba ad platforms The conclusions above are broadly borne out by a recent survey that we have undertaken. We conducted interviews with a wide range of brand owners and digital ad agencies with regard to the automation of their ad budgets. They have universally shown a rapidly growing tendency to embrace spending on China’s ad exchanges from current levels of less than 10%. Nearly all of those interviewed indeed viewed Tencent and Alibaba’s constant innovation in digital advertising as driving their growing preference for the platform.

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Ad exchange “mega- trends”

Four critical developments in China’s ad exchanges

Having established what we believe to be success factors above, we have isolated four important mega-trends as they relate to China’s ad exchanges below. We attempt to both profile these trends and determine which of the three major exchanges is best poised to dominate these trends:

 Mega trend 1: Programmatic buying and RTB - Tencent is driving significant gains in this area.

 Mega trend 2: Ad exchanges go mobile - Tencent offers the most interesting story

 Mega trend 3: Ad exchanges go omni-channel – Alibaba is leading on this front.

 Mega trend 4: Ad technology consolidation – Alibaba best captures this trend. Mega trend 1: Programmatic buying and RTB

Market leader iPinyou explains rapid growth of programmatic buying The advent of ad exchanges has been aided and abetted by the successful Programmatic buying to adoption of programmatic buying and real-time bidding. exceed RMB10b in 2015, As we explain earlier in this report, programmatic buying refers to the growing 70% YoY in 2016. purchase of digital advertising in an automated way through a variety of technology platforms, as opposed to the traditional process involving extensive human negotiations and various more manual, off-line processes. Successful programmatic buying relies on DSP’s, ad exchanges, SSP’s and DMP’s (please refer to definitions later in this report). iPinyou expects overall programmatic buying to grow more than 100% YoY to exceed RMB10b this year, and to expand by more than 70% in 2016.

Hyper-competitive industries driving programmatic and RTB iPinyou, a China’s leading independent DSP, has noticed that more intensely competitive industries such as e-commerce, FMCG, auto and finance are expanding their use of programmatic buying very aggressively. More traditional industries such as real estate, luxury, sports and fitness, and recreation, meanwhile have seen slower adoption.

As shown in figures below, the traditional industries largely commenced to embrace programmatic buying from the last quarter of 2014. We have historically viewed these industries as amongst the more advanced in their adoption of digital advertising. They, moreover, tend to be far more ROI focused than other verticals.

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Figure 11: Quarterly portion of programmatic ad Figure 12: Quarterly portion of programmatic ad spending out of annual budget 2014 – consumer- spending out of annual budget 2014– traditional oriented sectors industries 60% 90% 54% 82% 81% 51% 80% 74% 50% 48% 70% 66% 60% 40% 34% 50% 32% 50% 30% 27% 40% 30% 17% 20% 14% 20% 11% 7% 9% 10% 8% 10% 3% 5% 0% 0% 2% 0% 0% Real estate Luxury Home Sports & Movie & FMCG E-commerce Finance Auto 3C Travel decoration & fitness entertainment services renovation

1Q14 2Q14 3Q14 4Q14 1Q14 2Q14 3Q14 4Q14

Source: Deutsche Bank, iPinYou Source: Deutsche Bank, iPinYou

Overseas precedents would suggest that China’s brands could cut a vast majority of their digital ad budgets over to programmatic longer term. We note for instance that Google claims that 73% of its brand display marketing spend flowed through programmatic in 2014; P&G claims to spend 70% of its ad budget on programmatic buy, and nearly 100% of American Express digital ad budget is programmatic already. Adoption of programmatic meanwhile is generally incremental to the likes of Google, Alibaba, Tencent, and Baidu, as it usually represents inventory that would not be sold by their direct sales forces. iPinyou: spend shift towards programmatic buy will be faster in China China has a much larger digital ads market, and a much lower penetration of China’s programmatic ads programmatic buying, than most other countries. China clearly has substantial growth upside if we take the US market as a benchmark. The below chart penetration to reach 23% illustrates the projected trajectory of programmatic buy growth in both China by 2017 vs. 80% of U.S. and the US. As referred earlier, Magna Global expects China’s programmatic ads penetration to reach 23% in 2017 vs 80% in the U.S.

Figure 13: China’s digital display ad spend shifting toward programmatic buy

90% 80% 80% 75% 70% 70% 60% 60% 50% 40% 30% 23% 18% 20% 12% 10% 5% 0% 2014 2015E 2016E 2017E

China United States

Source: Magna Global Note: This is calculated based on the total programmatic spend as a percentage of total digital display-related ad spend for each year.

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iPinyou believes that the migration of digital ad budgets will happen at a more accelerated pace in China compared to other markets as:

 China has more and better data than most other markets in the world. iPinyou feels that Baidu, Alibaba & Tencent, along with various DSPs, already have accessible data in scale

 On-line video has become a powerful engine to programmatic spend as it is being adopted for online branding ever more pervasively. iPinyou for instance estimates that the share of video in its programmatic spend is already 35 %

 Mobile is already largely integrated with other media in China, while the emerging rich media ad segment is also encouraging broader programmatic spend. China’s big exchanges already well-equipped to accommodate programmatic spend We believe that leader Alibaba has 80-90% of its advertisers transacting programmatically, largely because all of its Taobao and Tmall merchants buy through an exchange-based process; Tencent meanwhile has enabled programmatic buying across a majority of its core properties’ ads inventory. Baidu, China’s leader in the highly automated search field, claims that a significant majority of its ads sales are done programmatically.

Only 12% of digital ad budgets will be spent in a programmatic fashion this year as discussed above. As the three big exchanges improve their offerings, we would expect broadening advertiser buy-in. We indeed expect China ad spend to continue to see an ongoing shift toward programmatic buy.

Programmatic buying enables re-targeting availability Re-targeting is a form of online advertising that can help advertisers keep their ads to display in front of bounced traffic after a visitor leaves the website. For most websites, only 2% of web traffic converts on the first visit. Re-targeting is a tool designed to help advertisers reach the remaining 98% of users who don’t convert right away.

A strong exchange ecosystem and an advanced algorithm underpin the basics of a successful re-targeting strategy. Re-targeting is a regarded by advertisers as a powerful conversion optimization tool, and it works best as a part of a larger advertising strategy. Strategies involving content marketing and targeted display works great for driving traffic and re-targeting can the other hand help increase conversions. iPinyou: programmatic is going mobile quickly While 100% growth in overall programmatic buying in China is impressive, iPinyou expects some 350% growth in mobile programmatic spend in the country this year alone, and another 300% in 2016. We explain the broader ad exchange trend toward mobile in our discussion of our next mega-trend below.

Tencent driving significant gains in RTB and programmatic Advertisers and ad tech partners describe the upgrade of Tencent’s exchange Tencent leading the step products throughout the first half of this year (specifically the GDT ad up to programmatic and exchange and its accompanying data management platform) as marking some of the most compelling improvements in supporting the spread of RTB programmatic and RTB in China today. Advertisers expect to be able to

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purchase ever-larger parts of Tencent’s core inventory on QQ and Weixin programmatically through the exchange, and the largely social-based targeting information that leading mobile SNS properties Weixin and QQ Mobile enable has been greeted quite positively by many advertisers.

Mega trend 2: Ad exchanges go mobile

As mobile traffic continues to overtake PC traffic, China’s advertisers are steadily shifting their ad budgets to mobile. Mobile advertising should longer term lend itself well to programmatic buying as:

 user behaviors on mobile vary much more widely than on PC (with usage scenarios ranging from sitting on the couch at home to watching a live concert at a stadium)

 users tend to utilize far more frequent, fragmented periods of time on mobile compared to PC

 mobile browsing, mobile apps etc tend to generate stronger user engagement than PC eMarketer indeed predicts that spending on display and search ads delivered to mobile internet-connected devices in China will reach USD14b this year, up from USD7.4bn 2014. In other words, mobile ad spend will account for 45% of all digital spend this year. It is clear that the Chinese ad exchanges will need to play an increasingly important role in brokering the buying and selling of mobile ad space.

As shown in the figure below, iResearch expects China’s programmatic display Mobile programmatic ad budgets to continue to grow at an attractive 81% CAGR to RMB28.3bn by market to grow at 112% to 2017E. Of the most prominent sub-trends, mobile programmatic should continue to gain traction, reflecting mobile’s increasing importance in the reach RMB3.8bn by 2017 overall online marketing sector. iResearch expects programmatic buying on mobile to grow at a three year CAGR of ~112% to reach RMB3.8bn by 2017E contributing to ~13% of China’s overall programmatic ad budget, from an approximately 8% share in 2014.

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Figure 14: China’s programmatic display ad budget to continue enjoy significant growth with mobile gaining increasing share

RMBbn 30 350% 300% 25 28.3 300% 217% 250% 20 180% 200% Mobile will increase its 15 125% 17.7 133% 150% contribution to 13% of 10 110% 10.2 74% 81% 100% programmatic buying by 5 60% 50% 2017 1.5 0.1 4.8 0.4 0.9 2.1 3.8 0 0% 2013 2014E 2015E 2016E 2017E Programmatic Mobile programmatic Programmatic YoY (RHS) Mobile programmatic YoY (RHS)

Source: Deutsche Bank, iResearch

China is a “mobile first” market China as of earlier this year had 5% more smartphones than PC’s. There are by contrast 15% more PC’s than smartphones in the US, and this disparity rises to 26% in the case of France, and 27% in Germany. Accessing mobile ad inventory in China is thus arguably far more important than in other countries.

Chinese smartphone users are moreover on their phones roughly nine hours a day, compared to Japan at 7.5, the US at 6.3 hours and the UK at 5.6. They specifically use their smartphones for shopping and research purposes more readily than their western counterparts (40% of Chinese smartphone owners use their phones for product research, versus ~28% in the US and 21% in the UK.) It is thus critical for China’s ad exchanges to offer connectivity to the mobile domain, moreover highly targeted and reliable connectivity. The following charts shows the comparison cross countries.

Figure 15: Percentage of smartphone owners more than Figure 16: Hours spent using mobile apps weekly PC owners More PCs than smartphones More smartphones than 9 8.5 5% China 8 7.5 6.7 -7% Taiwan 7 6.3 -8% U.K. 6 5.6 -8% Vietnam 5 -15% U.S. 4 -17% Australia 3 -23% New Zealand 2 -26% France 1 -27% Germany 0 -30% -20% -10% 0% 10% U.S. U.K. China Japan Australia

Source: Google DoubleClick Source: Google DoubleClick Note: Calculation is based on % of people with smartphones subtracted by the % of people with PCs

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A look into evolution of China’s mobile ad exchanges In China, basic mobile ad platforms came into operation in 2010 with ad aggregation platforms being introduced in 2011 to overcome the shortcomings faced by advertisers using the basic model (e.g., working with a single mobile ad network resulting in lower fill rate, the time consuming process of updating SDK’s and the need to wait for users to update apps, etc.). With the advancement of mobile technology, PC based advertising companies gradually started experimenting with mobile based programmatic buying during the latter half of 2012. However, due to a lack of knowledge around mobile advertising, the development process was slower than that of the PC. Nevertheless, by 2014, more robust mobile based ad exchanges, DSPs, and SSPs were introduced to the market creating a more concrete and comprehensive value chain in the sector. Accordingly, iResearch estimated the sector was worth ~RMB390.3m at the end of 2014 (with ~8% market share) and expects rapid growth, reaching ~RMB3.8bn by end of 2017E (~+165% CAGR from 2013-2017E), contributing for ~14% of the total market. Please refer to the figure below.

Figure 17: Rapidly growing mobile programmatic buying contribution

100% 5.1% 90% 13.6% 80% 70% 60%

50% 94.9% 40% 86.4% 30% 20% 10% 0% 2013 2017E

PC Mobile devices

Source: Deutsche Bank, iResearch

Major players in the China’s mobile ad exchange eco-system AdsMOGO (ad exchange & SSP – now integrated into TANX Mobile), Inmobi (DSP), and Limei (DSP) are the early entrants into the China mobile programmatic buying sector. China’s mobile ad exchanges consist of both open platforms such as Baidu’s BES, Google’s DoubleClick, and TANX/Mobile/AdsMOGO; and private platforms such as Youku Tudou, iQiyi PPS, and PPTV’s PPADX.

Mobile exchanges place ads into many different environments, from mobile web pages to mobile apps. Out of the open ad exchanges, some (e.g., DoubleClick, AdsMOGO AMAX) focus more on working with domestic app resources (including both home-grown apps and third party apps) and others (e.g., Inmobi) are generally better connected with overseas apps (including foreign apps and Chinese apps available abroad). The focus of the private ad exchanges meanwhile depends on in-house advertising resources. Figure 18 below summarizes the key features and differences of major mobile ad exchanges in China.

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Figure 18: China’s major mobile ad exchanges

Ad exchange Operator Nature Sources of publishers Placement Mobile pre- Distribution Type of ad movie ad channel Baidu Exchange Baidu Open Wangmeng.baidu.com, Mobile + PC Yes Mobile web + Pop ads (interstitial & Service Munion.baidu.com app banner ads), in-video ads

DoubleClick Google Open AdSense, AdMob Mobile + PC Yes Mobile web + In-video ads, pop up ads app

AMAX AdsMOGO Open Mostly domestic apps Mobile Yes App Native ads, pop up ads (interstitial & banner ads)

AdView AdView Open Mostly domestic apps Mobile Yes App Native ads, pop up ads (interstitial & banner ads), in-video ads

Miaozhen ADX Miaozhen Systems Open Domestic mobile Mobile + PC Yes Mobile web + In-video ads based video resources app

Appflood Papaya Mobile Open Mostly foreign apps Mobile No Mobile web + Pop up ads (interstitial & app banner ads)

Inmobi Inmobi Open Mostly foreign apps Mobile Yes Mobile web + Pop up ads, in-video ads, app native ads

Youku Tudou ADX Youku Tudou Private Pre-movie ads (in- Mobile + PC Yes Mobile web + In-video ads house) resources app

iQiyi PPS ADX iQiyi PPS Private Pre-movie ads (in- Mobile + PC Yes Mobile web + In-video ads house) resources app

PPADX PPTV Private Pre-movie ads (in- Mobile + PC Yes Mobile web + In-video ads house) resources app

Source: Deutsche Bank, iResearch

Key challenges ahead with mobile ad exchange Compared to PC-based DSPs, mobile DSPs face several challenges including the need to rematch mobile identifiers of the audience each time they replace their mobiles, shorter life cycle of mobile apps vs. websites on PCs (requiring the real-time updating of apps) etc. In addition, while demand from advertisers for ad space on mobiles grows at an increasing pace, the available ad space has grown at a slower rate given the limited real estate on mobile screens compared to PCs. This creates the greater need for more creative means and ways to achieve higher levels of efficiency and effectiveness in the use of mobile ad space than required by PC based approach.

In addition, there’s a lack of industry-wide quality standards and regulations in place preventing fake data being collected and used. This is a common issue faced by PC-based programmatic buying eco-systems as well.

Tencent offers the most interesting mobile ad exchange story With the increasing user preference towards mobiles over PCs, China internet companies are focusing with greater interest in expanding their existing business models to include mobile based platforms.

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 Tencent: Launched GDT ad exchange and DMP in 1H15, providing external DSPs the access to its core mobile inventories (e.g., QQ, Q- zone, Tencent News, QQ Music, etc.) and some external ad inventories through the Mobile Union partnership (e.g., Cheetah, Youku, TouTiao, etc).

 Alibaba: Alimama advertising group has established TANX Mobile (by incorporating much of the previously acquired AdsMOGO). Another acquired company, AdChina, meanwhile operates mobile ad exchange that claims to have integrated over 80,000 mobile apps and covered over 80% of China’s mobile internet users.

 Baidu: Baidu is aggressive at adding mobile inventories, although its mobile exchange service is relative weak. Baidu recently launched a mobile ad platform “DU AD Platform” (DAP), targeting to assist domestic app developers to access overseas advertisers. It contains smart algorithms to do audience analysis, ads loading and conversion improvement. We prefer Tencent as the industry leader with the most upside potential not only because of its strong presence in the everyday use of mobile social networking apps, Weixin and Mobile QQ, but more importantly due to the growing user behavior data that it is accumulating. Advertising should take off more once its mobile data is opened up to external parties.

Mega trend 3: Ad exchanges go omni-channel

People carrying activities across multiple screens throughout the day 90% of users switch We increasingly live in a “multi-screen” world. A user may for instance start amongst multiple screens the day reading the early edition of the news from a smartphone, work off a PC in the daytime during work, and switch to a tablet at night to review personal to complete tasks email and catch up on popular on-line programming before sleep. According to McKinsey research, 90% of people switch amongst multiple screens to complete tasks, and 38% of all customer journeys involve more than one channel of interaction. For instance, a consumer may browse products an e- commerce app on mobile and save a product in his/her shopping chart, only to switch to PC to finish the transaction.

Omni-channel: insights from iClick We draw many of our insights into the rise of omni-channel strategies and solutions from an extended set of conversations with a pioneer in this field, Hong Kong-based iClick Interactive. iClick has emerged from its origins as a largely search-focused ad technology company to become one of the industry’s most prominent multi-channel digital marketing platforms. The company seeks to deliver ads optimization and improved ROI for advertisers in Greater China across search, video, PC display, mobile and other emerging platforms. iClick operates a self-owned DSP, a cross-channel DMP, a mobile DSP and a search ad buy function through its proprietary platform.

The importance of third party solutions in omni-channel iClick continues to evolve its product offering to its mostly large accounts (both MNC and large Chinese advertisers.) These advertisers seek the right combination of mobile web, mobile app, video and desktop ad slots in order to follow and appeal to the multi-screen user. The company’s proprietary programmatic marketing platform leverages its neutral, third-party status to access multiple inventory sources at the same time and be able to locate the

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right audience across channels on behalf of the client. The ability to identify and track users and audiences across devices and media improves ROI across a wider inventory pool.

Engaging the user across channels increases engagement rates Advertisers indeed increasingly seek the right blend of the target audience, message, device, and the time in order to optimize their ROI. China programmatic and RTB leader, iPinyou presents below an interesting depiction of how ad impressions are delivered across devices and times of day. As depicted in Figure 20, a user’s engagement rate can be lifted as part of a cross- channel strategy, versus a pure mobile or PC campaign.

Figure 19: How multiple devices reach users at different Figure 20: Engagement rate in cross-screen is 5x that of time pure mobile 16% 15% Daytime 14% • Mobile Desktop • Tablet impressions are heavily skewed impressions are 12% the most constant toward the throughout the • Desktop nighttime hours. 10% day. impressions are highest during • Impressions are 9x 8% • Peak hour is work hours. higher than early usually at 7-9am, morning hours. 6% 5-7pm and before • Peak hour is bed 9pm-1am usually at 10am in 4% 3% a post-coffee 2% Morning break. Night time Mobile Tablet 0% Mobile Cross screen

Source: Deutsche Bank, iPinyou Source: Deutsche Bank, iPinyou

China’s growing embrace of omni-channel strategies According to a study by Experian Marketing services, 80% of marketers worldwide ran cross-channel marketing campaigns in 2014. iClick and other 80% of marketers worldwide leading China’s DSPs are also seeing increasing number of advertisers ran cross-channel marketing requiring an omni-channel advertising campaign in the Chinese context. In China, these multi-channel strategies are a mixture of PC, mobile and tablet, as campaigns in 2014 most young people nowadays spend a majority of their screen time on these three channels.

How closely the exchanges can track a single user across screens In the PC era, the average internet user’s behavior was largely tracked through the use of cookies. This approach saw varying levels of success as users often deleted cookies, or disabled them completely. In the mobile era, advertisers have a wider array of solutions in tracking smartphone users. Software development kits (SDK’s) exist across various platforms to assist in tracking, as do “WAAP cookies.” A user’s phone number, handset series number and unique device ID’s all can contribute to an unprecedented level of targeting for advertisers. Complications tend to arise, however, when trying to track users across screens due to the different tracking methodologies that exist specific to each type of device.

Log-in traffic – Key to success in leveraging omni-channel Those platforms whose services require unique and real-name log-in accounts are clearly advantaged relative to those properties that do not require users to log-in, or whose logged in users after have non-real-name account connectivity. The core e-commerce properties of Alibaba, for instance, enjoy unrivaled

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insight into the user. A shopper on Taobao or Tmall must be logged on in order to transact on the platform. The information associated with that user’s behavior moreover is of great commercial value.

Although many visitors to Tencent’s popular properties do not need to be logged on to enjoy the service (eg – Tencent News, Finance, Video, etc), the platform’s marquee properties (such as Weixin and QQ Mobile) are effectively 100% logged in, and we believe a vast majority of logged in users are now effectively real-name. Baidu, by contrast, has far lower log-in rates. Although the user enjoys a far more tailored content by logging in to use Baidu Post, Baidu Knows or other company properties, we estimate that only 15-20% Baidu usage is done on a logged in basis. These diminished logged-in traffic levels hamper Baidu’s cross-screen capabilities. Nevertheless, we believe that Baidu has succeeded in applying a range of tracking technologies to be able to identify over 30% of its users across screens. We expect all major players in the digital advertising eco-system to work tirelessly to improve omni-screen competences; these sought after higher mapping ratio will depend upon technology advancements and the opening up of data.

Alibaba China’s leader in omni-channel We believe that Alibaba has made the greatest progress in following a single user across devices and activities. As part of its Dharma Sword initiative, Alibaba through Alimama advertising network and TANX has created “Super- IDs,” which help track the user from desktop to mobile, smartphone to tablet, mobile browser to mobile app, etc. In addition to tracking a logged-in Taobao customer across devices, Alibaba moreover has made measurable progress in identifying its e-commerce customers increasingly across their Sina Weibo account, to UCweb browser and Autonavi map usage, and even outdoor advertising. We expect TANX to continue to lead the China exchanges in offering an omni-channel strategy.

Mega trend 4: Ad technology consolidation

One of the historic perils for emerging ad exchanges, DSP’s and other areas of “ad tech” is that the space becomes fractured with a large number of competitors, and ultimately sub-scaled players. We have however begun to see signs of consolidation, as shown in the table below. Consolidation moreover seems to be happening at multiple levels. iClick, profiled briefly in our “omni-channel” discussion above, has continuously expanded its value proposition to its customers, both organically and inorganically. iClick in August of this year for instance announced the acquisition of leading mobile DSP, OptAim, to enhance its mobile and cross-screen capabilities. We believe that OptAim for instance is the one of the largest external ad revenue contributors to Tencent GDT. iClick had earlier acquired B share, a leading DMP. In addition to these landmark deals, we profile a sampling of other transactions since March of 2014.

Deutsche Bank AG/Hong Kong Page 29

5 December 2015

Software & Services China Internet

Figure 21: Summary of M&A in digital ads space in China Target company Nature of the company Investors Amount of investment % shareholding Date of investment

Cross-channel & mobile Banyan Capital + Avazu US$48m not disclosed Mar-14 focused ad platform other investors MediaV Adnetwork Ad network Qihoo US$134.3m Controlling stake May-14 Dream capital + Adsame Digital marketing US$30m not disclosed May-14 Yihe Lianchuang Ascent Capital + Vizury Digital CRM US&16m not disclosed Jun-14 Intel Capital Zamplus Targeted marketing Ctrip not disclosed not disclosed Sep-14 Cross-channel iClick Blue Focus Group US$60m 14.59% Dec-14 programamtic ad platform Admaster Data Analytics Blue Focus Group US$24.375m 11.69% Dec-14 Zamplus DSP Blue Focus Group US$25m 14.29% Dec-14 Advertising Operation Behe Blue Focus Group US$43m not disclosed Dec-14 System AdChina Ad network/DSP/DMP/SSP Alibaba not disclosed Controlling stake Jan-15 Domob Ltd - US$178.9m Domob Ltd - 100% DoMob Mobile ad network Blue Focus Group Jun-15 Domob Beijing - US$109.2m Domob Beijing - 95% Madhouse Ad agency Blue Focus Group US$71.2m 54.77% Jun-15 Source: Deutsche Bank, Bluefocusgroup, RTB China, Qihoo company, iResearch

Scale crucial to remaining relevant in ad tech; will the small guys get pushed out? A select number of advertising-focused companies are indeed acquiring others to build up sufficient scale within the industry. Shenzhen-listed Blue Focus Group in particular has sought to build its scale and range of offerings through acquisitions, As we discuss in our Appendix, many market-watchers wonder whether smaller players will be able to exist, particularly as Tencent, Alibaba and Baidu seek to grow their respective value propositions in the space. The key independent players will need enough scale (media buy volume, customer reach, data source, cross-channel capabilities) to establish a firm foothold in order in turn to create add value to both advertisers (by delivering results) and suppliers (by bringing about incremental spend).

Alibaba best positioned in this era of consolidation In terms of ad tech consolidation among companies under study in this report, Alibaba has made some of the more successful acquisitions in our minds, specifically of AdsMOGO and AdChina. The acquisition of AdChina earlier this year served to expand the commercial reach and the functionality of its ad exchange ecosystem. AdChina, having developed into a leading network and DSP, intends to bring a long list of large multinational and domestic advertisers. Alibaba’s previous advertiser focus tended to be heavily weighted toward small merchants given the C2C nature of Taobao. Although there remains risk in the integration of AdChina and Alibaba (we for instance have heard that several key executives and salespeople have left AdChina), we would not be surprised to see Alibaba continue to make selective investments in ad tech to increase its heft and value proposition to both advertisers and publishers.

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In the next section, we briefly introduce the big three ad exchanges in China, i.e. Tencent GDT ad exchange, Alimama Ad Network, and Baidu Exchange Service. Please refer to the paralleled published reports titled “GDT and the USD10b ad opportunity”, “e-Commerce outside, ad tech inside”, and “The BES Exchange: missing the mobile link”, for detailed analysis of their respective ad exchanges.

Deutsche Bank AG/Hong Kong Page 31

5 December 2015

Software & Services China Internet

The Tencent GDT ad exchange

Tencent GDT: strong in premium, social and mobile inventory

A private exchange that is coming on strong Tencent’s Guangdiantong (GDT) platform is the latest major player to hit China’s ad exchange scene. Of the many assets and strengths that Tencent boasts, GDT takes advantage specifically of the following:

 Mobile: Tencent has an unrivaled presence across the mobile landscape through its two core properties, Mobile QQ and Weixin. Tencent Mobile QQ claimed 639m monthly active users, while Weixin reported 650m monthly active users in 3Q15. The combined mobile user base (650m) represents 97% of China total internet users and effectively covers the entirety of China’s mobile internet users, according to CNNIC data. We estimate that over 55% of Weixin users open the app more than 10 times a day, and 25% open 30 times a day. These dominant properties play host to a wide range of daily behaviors, and have the ability to capture a tremendous amount of data across many attributes.

 Social: QQ’s and Weixin’s “social cues” specifically are being used to improve ad targeting (e.g. if I like a certain product, my friend or peer set may also like it).

 Premium: Tencent as such holds much of the market’s most premium ad inventory. Its successful Q-zone stream ads and Weixin official accounts have more recently been complemented by Moments-based form factor, and we expect both a widening range of products and gradual opening of these platforms to drive strong growth going forward. While an increasing amount of Tencent inventory is moving to the GDT exchange, much inventory is not fully programmatic. Ad agencies still for instance need to negotiate with Tencent’s ad team to buy branded ads, etc.

Furthermore, like nearly all major digital ad placement platforms, Tencent has opened up only a portion of the data it generates to its advertiser-customers. While advertisers thus still have limited precision advertising capabilities, most indicate that targeting is steadily improving behind Tencent’s new offerings.

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Model updated:04 December 2015 Fiscal year end 31-Dec 2012 2013 2014 2015E 2016E 2017E

Running the numbers Financial Summary Asia DB EPS (CNY) 1.53 1.82 2.59 3.37 4.43 5.57 Reported EPS (CNY) 1.37 1.66 2.54 3.09 4.04 5.07 China DPS (CNY) 0.17 0.21 0.25 0.33 0.41 0.41 BVPS (CNY) 4.5 6.3 8.7 11.7 15.6 20.5 Software & Services Weighted average shares (m) 9,133 9,180 9,234 9,285 9,311 9,313 Tencent Average market cap (CNYm) 337,902 498,025 850,368 1,132,682 1,132,682 1,132,682 Enterprise value (CNYm) 312,856 458,336 771,214 1,042,182 993,305 961,027 Reuters: 0700.HK Bloomberg: 700 HK Valuation Metrics P/E (DB) (x) 24.2 29.8 35.6 37.0 28.1 22.4 Buy P/E (Reported) (x) 27.0 32.7 36.2 40.4 30.9 24.6 Price (4 Dec 15) HKD 151.00 P/BV (x) 8.91 12.39 10.32 10.68 7.99 6.08

Target Price HKD 173.00 FCF Yield (%) 4.5 3.9 3.3 1.8 5.2 3.9 Dividend Yield (%) 0.5 0.4 0.3 0.3 0.3 0.3 52 Week range HKD 105.30 - 170.50 EV/Sales (x) 7.1 7.6 9.8 10.5 7.9 5.9 Market Cap (m) HKDm 1,372,277 EV/EBITDA (x) 17.3 20.1 21.8 22.7 16.9 13.3 EV/EBIT (x) 20.2 23.9 25.3 26.1 19.4 15.3 USDm 177,065 Income Statement (CNYm) Company Profile Sales revenue 43,894 60,437 78,932 99,679 126,318 162,039 Tencent Holdings Ltd provides internet, mobile and Gross profit 25,686 32,658 48,059 59,363 74,811 95,147 telecommunication value-added services in China.The EBITDA 18,100 22,784 35,343 45,860 58,682 72,492 company has an instant messaging community in China. Depreciation 2,620 3,590 4,801 5,921 7,503 9,625 Tencent also provides online advertising services. Amortisation 0 0 0 0 0 0 EBIT 15,479 19,194 30,542 39,939 51,178 62,867 Net interest income(expense) 0 0 0 0 0 0 Associates/affiliates 0 0 0 0 0 0 Exceptionals/extraordinaries -26 -43 -1 0 0 0 Other pre-tax income/(expense) -402 129 -1,528 -3,902 -4,732 -4,732 Profit before tax 15,051 19,280 29,013 36,037 46,446 58,135 Price Performance Income tax expense 2,266 3,718 5,125 6,652 7,941 9,939 Minorities 53 61 78 407 556 556 180 Other post-tax income/(expense) 0 0 0 0 0 0 160 Net profit 12,732 15,501 23,810 28,978 37,950 47,640 140 DB adjustments (including dilution) 1,492 1,478 414 2,627 3,733 4,737 120 DB Net profit 14,224 16,980 24,224 31,605 41,682 52,377 100

80 Cash Flow (CNYm) 60 Dec 13Mar 14Jun 14Sep 14Dec 14Mar 15Jun 15Sep 15 Cash flow from operations 19,376 24,313 32,633 30,080 70,282 57,880 Net Capex -4,087 -4,771 -4,256 -8,971 -10,105 -12,963 Tencent HANG SENG INDEX (Rebased) Free cash flow 15,289 19,542 28,377 21,109 60,177 44,917 Equity raised/(bought back) 97 308 299 0 0 0 Margin Trends Dividends paid -1,225 -1,541 -1,919 -2,336 -3,059 -3,840 Net inc/(dec) in borrowings -1,279 4,699 20,619 0 0 0 48 Other investing/financing cash flows -11,239 -14,860 -22,383 -4,877 -5,237 -5,796 44 Net cash flow 1,642 8,148 24,993 13,896 51,881 35,282 40 Change in working capital 3,508 8,186 3,832 -5,417 21,834 -154

36 Balance Sheet (CNYm) 32 Cash and other liquid assets 13,383 20,228 42,713 56,025 107,511 142,397 28 Tangible fixed assets 8,753 11,605 12,499 15,549 18,151 21,489 12 13 14 15E 16E 17E Goodwill/intangible assets 4,719 4,103 9,304 11,624 13,944 16,264 EBITDA Margin EBIT Margin Associates/investments 40,196 59,868 92,215 95,333 98,318 101,862

Other assets 8,205 11,431 14,435 17,410 18,823 27,572 Growth & Profitability Total assets 75,256 107,235 171,166 195,942 256,747 309,583 Interest bearing debt 12,208 16,653 35,802 35,802 35,802 35,802 60 40 Other liabilities 20,899 32,119 53,240 49,230 72,664 79,220 50 30 Total liabilities 33,108 48,772 89,042 85,032 108,466 115,022 40 Shareholders' equity 41,298 57,945 80,013 108,392 145,207 190,931 30 20 Minorities 851 518 2,111 2,518 3,074 3,630 20 10 Total shareholders' equity 42,148 58,463 82,124 110,910 148,281 194,561 10 Net debt -1,175 -3,575 -6,911 -20,223 -71,709 -106,595 0 0 12 13 14 15E 16E 17E Key Company Metrics Sales growth (%) 54.0 37.7 30.6 26.3 26.7 28.3 Sales growth (LHS) ROE (RHS) DB EPS growth (%) 29.8 19.1 42.3 30.1 31.7 25.6 Solvency EBITDA Margin (%) 41.2 37.7 44.8 46.0 46.5 44.7 EBIT Margin (%) 35.3 31.8 38.7 40.1 40.5 38.8 0 Payout ratio (%) 12.1 12.4 9.8 10.6 10.1 8.1 -10 ROE (%) 36.5 31.2 34.5 30.8 29.9 28.3 -20 Capex/sales (%) 9.3 7.9 5.4 9.0 8.0 8.0 -30 Capex/depreciation (x) 1.6 1.3 0.9 1.5 1.3 1.3 -40 Net debt/equity (%) -2.8 -6.1 -8.4 -18.2 -48.4 -54.8 -50 Net interest cover (x) nm nm nm nm nm nm

-60 Source: Company data, Deutsche Bank estimates 12 13 14 15E 16E 17E

Net debt/equity (LHS) Net interest cover (RHS)

Alan Hellawell III +852 2203 6240 [email protected]

Deutsche Bank AG/Hong Kong Page 33

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Software & Services China Internet

The Alimama Ad Network

China’s most dominant exchange, leveraging unrivaled big data capabilities

China’s widest spanning exchange with e-commerce characteristics Our accompanying study of China’s three main digital ad exchanges reveals that Alibaba has achieved clear dominance across several fronts of ad technology. The Alimama Advertising Network serves to place ads both on Alibaba’s internal properties on the one hand, and on third party publishers through the TANX exchange on the other. We view the greatest strategic advantages of the Alimama Advertising Network as the following:

 Between helping merchants place ads within China’s largest e- commerce platform, and additionally offering connectivity to a growing number of external publishers, Alimama Advertising Network aggregates the greatest ads volume (impressions) of any solution in China on our estimates. We believe that Alimama Advertising Network as of 1H 2015 managed over 15bn impressions per day; over 10b daily page views (PVs) on PC and more than 5b daily PVs on mobile, representing both resources inside and outside of Taobao.

 With its origins as China’s leading e-commerce platform, Alibaba is renowned for its targeted advertising capabilities. Much of this ever-improving targeting is based on China’s largest collection of consumer transaction data and purchasing behaviors. Alibaba’s customer base clearly has high purchase intent, and thus Alimama Advertising Network can offer ad products with unrivaled commerciality. Through its “Dharma Sword” effort (detailed below), Alibaba can assign “Super-ID’s” to users and track them across a wide range of properties.

 Alibaba according to many of the advertisers whom we interviewed, offers the market the most comprehensive family of digital ad tools and properties, ranging from its TANX and TANX Mobile exchanges, to some of the market’s most robust DSP, SSP, and DMP-related products; along with connectivity to several ad networks.

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Model updated:01 December 2015 Fiscal year end 31-Mar 2013 2014 2015 2016E 2017E 2018E

Running the numbers Financial Summary Asia DB EPS (CNY) 5.76 11.80 12.96 16.80 22.69 30.34 Reported EPS (CNY) 3.52 9.90 9.58 26.82 15.58 23.20 China DPS (CNY) 0.00 0.00 0.00 0.00 0.00 0.00 BVPS (CNY) 4.6 18.3 60.2 92.4 113.3 141.6 Software & Services Weighted average shares (m) 2,294 2,175 2,425 2,499 2,552 2,606 Alibaba Average market cap (CNYm) na na 1,444,860 1,259,534 1,259,534 1,259,534 Enterprise value (CNYm) na na 1,346,827 1,074,204 1,013,683 931,525 Reuters: BABA.N Bloomberg: BABA US Valuation Metrics P/E (DB) (x) na na 46.0 31.5 23.3 17.4 Buy P/E (Reported) (x) na na 62.2 19.7 33.9 22.8 Price (3 Dec 15) USD 82.59 P/BV (x) 0.00 0.00 8.56 5.60 4.57 3.66

Target Price USD 99.00 FCF Yield (%) na na 2.3 6.7 4.4 5.9 Dividend Yield (%) na na 0.0 0.0 0.0 0.0 52 Week range USD 57.39 - 110.65 EV/Sales (x) nm nm 17.7 11.0 7.7 5.3 Market Cap (m) EURm 181,495 EV/EBITDA (x) nm nm 52.5 32.6 20.0 12.4 EV/EBIT (x) nm nm 58.2 36.7 22.2 13.4 USDm 196,895 Income Statement (CNYm) Company Profile Sales revenue 34,517 52,504 76,204 97,965 131,732 175,518 Founded in 1999, Alibaba leads the China retail market Gross profit 25,473 40,159 52,607 68,695 94,453 127,667 through Taobao (the largest online shopping platform in EBITDA 11,731 26,303 25,636 32,926 50,575 75,192 China based on GMV),Tmall (the largest 3rd party platform Depreciation 675 1,024 237 1,537 2,918 4,626 for retailers/brands in terms of GMV) and Juhuasuan (a Amortisation 305 359 2,264 2,102 1,979 1,285 leading China group buying platform). The company caters EBIT 10,751 24,920 23,135 29,286 45,678 69,281 to global wholesale market through Alibaba.com and Net interest income(expense) -1,533 -547 6,705 45,718 2,426 3,799 China wholesale market through 1688.com. Alibaba also Associates/affiliates -6 -203 -1,590 -773 -1,168 -1,135 serves the global consumer market place via. AliExpress Exceptionals/extraordinaries 0 0 0 0 0 0 and also provides cloud computing services such as data mining, processing and storage. Other pre-tax income/(expense) 894 2,429 2,486 3,526 6,776 9,042 Profit before tax 10,112 26,802 32,326 78,530 54,880 82,122 Price Performance Income tax expense 1,457 3,196 6,416 8,072 12,544 18,941 Minorities 117 88 59 -53 -58 -64 120 Other post-tax income/(expense) -128 -239 -112 0 0 0 105 Net profit 8,404 23,076 24,149 69,738 41,226 62,110

90 DB adjustments (including dilution) 5,348 4,446 8,514 -26,066 18,811 19,121 75 DB Net profit 13,752 27,522 32,663 43,673 60,038 81,231 60 Cash Flow (CNYm) 45 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Cash flow from operations 14,476 26,379 41,217 95,335 67,873 91,132 Net Capex -2,202 -4,776 -7,705 -7,347 -8,563 -10,531 Alibaba NASDAQ 100 (Rebased) Free cash flow 12,274 21,603 33,512 87,987 59,310 80,601 Equity raised/(bought back) -28,349 -3,425 61,334 0 0 0 Margin Trends Dividends paid 0 0 -61 0 0 0 Net inc/(dec) in borrowings 26,932 12,789 -22,713 0 0 0 52 Other investing/financing cash flows 2,682 -28,318 -45,681 -1,959 -2,635 -3,510 48 Net cash flow 13,539 2,649 26,391 86,028 56,676 77,091 44 Change in working capital 5,964 4,682 13,528 4,770 2,996 4,054 40 36 Balance Sheet (CNYm) 32 Cash and other liquid assets 34,083 37,966 110,490 196,518 253,194 330,284 28 Tangible fixed assets 3,808 5,581 9,139 12,847 16,513 21,133 13 14 15 16E 17E 18E Goodwill/intangible assets 13,523 15,359 51,613 49,511 47,532 46,247 EBITDA Margin EBIT Margin Associates/investments 5,341 30,340 52,110 53,327 57,114 62,118

Other assets 7,031 22,303 32,082 24,204 25,961 28,241 Growth & Profitability Total assets 63,786 111,549 255,434 336,406 400,313 488,022 Interest bearing debt 33,101 41,075 52,593 52,593 52,593 52,593 80 100 Other liabilities 19,639 29,656 44,770 40,919 46,826 54,653 60 80 Total liabilities 52,740 70,731 97,363 93,512 99,419 107,246 60 Shareholders' equity 10,509 39,739 146,097 230,973 289,031 368,977 40 Minorities 537 1,079 11,974 11,921 11,863 11,800 40 20 Total shareholders' equity 11,046 40,818 158,071 242,894 300,895 380,777 20 Net debt -982 3,109 -57,897 -143,925 -200,601 -277,691 0 0 13 14 15 16E 17E 18E Key Company Metrics Sales growth (%) 72.4 52.1 45.1 28.6 34.5 33.2 Sales growth (LHS) ROE (RHS)

DB EPS growth (%) 141.4 105.0 9.8 29.6 35.0 33.7 Solvency EBITDA Margin (%) 34.0 50.1 33.6 33.6 38.4 42.8 EBIT Margin (%) 31.1 47.5 30.4 29.9 34.7 39.5 20 50 Payout ratio (%) 0.0 0.0 0.0 0.0 0.0 0.0 0 40 ROE (%) 40.0 91.8 26.0 37.0 15.9 18.9 Capex/sales (%) 7.3 9.1 10.1 7.5 6.5 6.0 -20 30 Capex/depreciation (x) 3.1 3.6 3.3 2.0 1.7 1.8 -40 20 Net debt/equity (%) -8.9 7.6 -36.6 -59.3 -66.7 -72.9 -60 10 Net interest cover (x) 7.0 45.6 nm nm nm nm

-80 0 Source: Company data, Deutsche Bank estimates 13 14 15 16E 17E 18E

Net debt/equity (LHS) Net interest cover (RHS)

Alan Hellawell III +852 2203 6240 [email protected]

Deutsche Bank AG/Hong Kong Page 35

5 December 2015

Software & Services China Internet

Baidu BES

Baidu Exchange Service: strong in ad demand, Baidu Union and video

Baidu’s ad exchange, Baidu Exchange Service (BES) differentiates itself in the following ways:

 As China’s largest search engine, Baidu has accumulated a large portfolio of SME advertisers, in addition to more than 1,000 key accounts (KA’s.).

 Baidu aggregates the second largest ad volume in China through Baidu Union. Baidu Union gathers third party traffic, and complements the exchange with tremendous long tail media resources.

 Baidu is well positioned in video, i.e. iQiyi. An increasing amount of video is already connected to the exchange.

 Baidu has a wide range of internal display properties such as Baidu Post, Baidu Knows etc.

 Advertisers report back that the major components of Baidu’s exchange (i.e. its DSP, SSP, DMP, the Baidu Tongji data analysis tool), while not yet as well integrated as the other two exchanges, are beginning to coalesce.

Although Baidu possesses the above advantages in China market, we find the company is in short of a few success factors to capture the programmatic trend:

 Baidu has a relatively low percentage of “log-in” traffic, rendering user targeting more challenging.

 The company has yet to integrate many mobile assets into its exchange.

 Several of Baidu’s display properties are not fully connected to the exchange

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Model updated:01updated:04 December 2015 Fiscal year end 31-MarDec 20132012 20142013 20152014 2016E2015E 2017E2016E 2018E2017E

Running the numbers Financial Summary Asia DB EPS (CNY) 30.505.76 11.8031.49 12.9640.24 16.8036.36 22.6946.38 30.3464.76 ReportedReported EPS (CNY) 29.893.52 30.029.90 37.609.58 26.8232.37 15.5841.80 23.2059.33 China DPS (CNY) 0.00 0.00 0.00 0.00 0.00 0.00 BVPS (CNY) 74.64.6 109.818.3 147.160.2 186.492.4 113.3235.2 141.6302.8 Software & ServicesServices Weighted average shares (m) 2,294349 2,175350 2,425350 2,499351 2,552351 2,606349 AlibabaBaidu Average market cap (CNYm) 264,914na 258,733na 1,444,860417,178 1,282,378463,915 1,282,378463,915 1,282,378463,915 Enterprise value (CNYm) 235,005na 242,209na 1,346,827387,748 1,097,047418,194 1,036,527402,038 954,36377,6198 Reuters: BABA.NBIDU.OQ Bloomberg:Bloomberg: BABABIDU US Valuation Metrics P/E (DB) (x) 24.9na 23.5na 46.029.6 32.036.5 23.728.6 17.720.5 BuyHold P/E (Reported) (x) 25.4na 24.6na 62.231.7 20.141.0 34.531.8 23.222.4 Price (30(3 Dec Nov 15) 15) USDUSD 207.48 84.08 P/BV (x) 0.008.49 0.009.96 8.569.55 5.707.12 4.655.64 3.724.38

Target Price USDUSD 189.00 99.00 FCF Yield (%) 3.6na 4.2na 2.33.2 6.53.6 4.33.4 5.85.4 Dividend Yield (%) 0.0na 0.0na 0.0 0.0 0.0 0.0 52 Week range USDUSD 132.37 57.39 - 110.65234.88 EV/Sales (x) 10.5nm nm7.6 17.77.9 11.26.3 7.95.0 5.43.8 Market Cap (m) EURmEURm 189,799 66,849 EV/EBITDA (x) 18.7nm 17.5nm 52.523.1 33.331.0 20.525.0 12.716.3 EV/EBIT (x) 21.3nm 21.6nm 58.230.3 37.541.1 22.728.6 13.817.8 USDmUSDm 200,447 72,521 Income Statement (CNYm) Company Profile Sales revenue 34,51722,306 52,50431,944 76,20449,052 97,96566,129 131,73280,473 175,51899,231 FoundedBaidu is in a 1999,leading Alibaba internet leads search the engineChina retail oper ator market in Gross profit 25,47317,383 40,15923,148 52,60734,139 68,69542,853 94,45351,681 127,66763,757 throughChina. The Taobao company (the largest offers a online variety shopping of search platform services in EBITDA 11,73112,567 26,313,84403 25,63616,776 32,92613,482 50,57516,084 75,19223,155 Chinaincluding based algorithmic on GMV), search,Tmall (the enterprise largest search;3rd party and platform music, Depreciation 1,515675 1,0242,652 3,972237 1,5373,306 2,9182,012 4,6261,985 fornews retailers/brands and image search. in terms The company of GMV) andgenerates Juhuasuan revenue (a Amortisation 3050 3590 2,2640 2,1020 1,9790 1,2850 leadingfrom selling China pay group-for- performancebuying platform). key-word The companyads. caters EBIT 10,75111,051 24,92011,192 23,13512,804 29,28610,176 45,67814,072 69,28121,171 to global wholesale market through Alibaba.com and Net interest income(expense) -1,533759 -547861 6,7051,364 45,7181,365 2,4261,482 3,7991,713 China wholesale market through 1688.com. Alibaba also Associates/affiliAssociates/affiliatesates -60 -2030 -1,5900 -7730 -1,1680 -1,1350 serves the global consumer market place via. AliExpress Exceptionals/extraordinaries 0 0 0 0 0 0 and also provides cloud computing services such as data mining, processing and storage. Other pre-tax income/(expense) 894156 2,429132 2,486307 3,526740 6,7761,014 9,0421,266 Profit before tax 10,11211,965 26,80212,185 32,32614,475 78,53012,282 54,88016,568 82,12224,150 Price Performance Income tax expense 1,4571,574 3,1961,829 6,4162,231 8,0722,386 12,53,31444 18,9414,830 Minorities 117-65 -16388 -94459 -1,472-53 -1,440-58 -1,440-64 280120 Other post-tax income/(expense) -1280 -2390 -1120 0 0 0 Net profit 10,4568,404 23,07610,519 24,14913,187 69,73811,367 41,22614,695 62,11020,760 240105

90 DB adjustments (including dilution) 5,348212 4,446515 8,514928 -26,0661,403 18,8111,609 19,1211,900 200 75 DB Net profit 13,75210,668 27,511,03422 32,66314,115 43,67312,770 60,03816,304 81,23122,660 16060 Cash Flow (CNYm) 12045 DecSep 1413Mar 14DecJun 14 14SepMar 14Dec 15 14MarJun 15 15Jun 15SepSep 15 15 Cash flow from operations 14,47611,908 26,37913,657 41,21718,091 95,33519,380 67,87319,222 91,13229,123 Net Capex -2,2022,311 -4,7762,757 -7,7054,827 -7,3472,645 -8,5633,219 -10,531-3,969 BaiduAlibaba HANGNASDAQ SENG INDEX 100 (Rebased) (Rebased) Free cash flow 12,2749,597 21,60310,901 33,51213,263 87,98716,735 59,31016,003 80,60125,154 Equity raised/(bought bback)ack) -28,349157 -3,4251,554 61,3342,040 0 0 0 Margin TrendsTrends Dividends paid 0 0 -338-61 -4000 -3710 -4800 Net inc/(dec) in borrowings 26,9329,389 12,7896,025 -22,7137,708 0 0 0 5260 Other investing/financing cash flows -11,4782,682 -28,31820,803 -45,68116,269 -1,959-76 -2,6350 -3,5100 5048 Net cash flow 13,5397,665 -2,6492,324 26,3910 86,02816,259 56,67615,632 77,09124,674 4044 Change in working capital 5,964696 4,6821,119 13,5283,300 4,7703,264 2,9961,287 4,0545,402 40 3630 Balance Sheet (CNYm) 20 32 Cash and other liquid assets 34,08332,880 37,96638,686 110,49058,084 196,51874,343 253,19489,975 330,284114,649 2810 Tangible fixed assets 3,8083,888 5,5815,370 9,1398,705 12,8478,044 16,5139,251 21,13311,236 1312 1413 1514 16E15E 17E16E 18E17E Goodwill/intangibleGoodwill/intangible assets 13,5235,465 15,35920,495 51,61320,993 49,51120,993 47,53220,993 46,24720,993 EBITDA Margin EBIT Margin Associates/investments 5,341803 30,340635 52,1102,879 53,3272,909 57,1143,121 62,1183,584

Other assets 7,0312,632 22,3035,800 32,0829,000 24,2049,888 25,96111,589 28,24113,648 Growth & Profitability Total assets 63,78645,669 111,54970,986 255,43499,661 336,406116,177 400,313134,929 488,022164,110 Interest bearing debt 33,1012,615 41,020,55675 52,59328,553 52,59330,023 52,59331,150 52,59333,308 8060 10060 Other liabilities 19,63915,838 29,6569,764 44,77016,603 40,91919,285 46,82621,146 54,65326,449 50 50 60 80 Total liabilities 52,74018,454 70,73130,321 97,36345,156 93,51249,308 99,41952,296 107,24659,757 40 40 60 Shareholders' equity 10,50926,055 39,73938,425 146,09751,526 230,97365,361 289,03182,565 368,977105,725 3040 30 Minorities 1,160537 1,0792,240 11,9742,980 11,921,5081 11,86368 11,800-1,372 40 20 20 20 Total shareholders' equity 11,04627,215 40,81840,665 158,07154,506 242,89466,869 300,89582,633 380,777104,353 10 2010 Net debt -30,265-982 -18,1303,109 -57,89729,531 -143,925-44,321 -200,601-58,825 -277,691-81,341 0 00 1312 1413 1514 16E15E 17E16E 18E17E Key Company Metrics Sales growth (%) 72.453.8 52.143.2 45.153.6 28.634.8 34.521.7 33.223.3 Sales growth (LHS) ROE (RHS) DB EPS growth (%) 141.457.0 105.03.3 27.89.8 29.6-9.6 35.027.5 33.739.6 Solvency EBITDA Margin (%) 34.056.3 50.143.3 33.634.2 33.620.4 38.420.0 42.823.3 EBIT Margin (%) 31.149.5 47.535.0 30.426.1 29.915.4 34.717.5 39.521.3 200 50 Payout ratio (%) 0.0 0.0 0.0 0.0 0.0 0.0 -020 40 ROE (%) 40.050.6 91.832.6 26.029.3 37.019.5 15.919.9 18.922.1 -40 Capex/sales (%) 10.47.3 9.18.6 10.19.8 7.54.0 6.54.0 6.04.0 -20 30 -60 Capex/depreciation (x) 3.1.51 3.61.0 3.31.2 2.00.8 1.71.6 1.82.0 -40 20 -80 Net debt/equity (%) -111.2-8.9 -44.67.6 -36.654.2 -59.366.3 -66.771.2 -72.977.9 -10060 10 Net interest cover (x) nm7.0 45.6nm nm nm nm nm

-12080 0 Source: Company data, Deutsche Bank estimates 1312 1413 15 14 16E15E 17E 16E 18E 17E

Net debt/equity (LHS) Net interest cover (RHS)

Alan Hellawell III +85+8522 2203 6240 [email protected]

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Appendix: Ad exchange basics

What you do need to know –three subsidiary concepts While the digital advertising space sees seemingly endless innovation, with new technologies and new solutions being announced, any report on ad exchanges would be remiss not to profile three other supporting components:

The data management platform (DMP): Successful RTB-based and programmatic buying requires a large amount of data (such as “audience insights”) and technology in order to reach the right person, at the right time, with the right message. A DMP is a centralized platform that aggregates many types of data (first-party tracking information, third-party audience data from other databases) all in order to support as well-informed and well-targeted a digital ads buy as possible.

The demand side platform (DSP): A DSP offers the advertiser a “front end” or an interface to an exchange. It is an automated platform that assists advertisers in several ways to enhance the efficiency and effectiveness of the whole ad inventory buying process, and thereby enabling them to boost the ROI of their advertising budgets.

The demand side platform is a necessary “front-end” which allows the buyer to access inventory through the exchange. The more sophisticated DSP’s run algorithms to ensure that the advertiser is maximizing the ROI of its ad purchase. It may recommend to a resort owner, for instance, to buy a an ad slot on a Weixin public accounts page that deals with summer vacation ideas in the evening, or to purchase a banner ad slot on the desktop travel website in the Tier One markets of Beijing, Shanghai and Guangzhou during weekend intervals to maximize exposure to its target audience, its click-through rate, conversion rate, and other measurable forms of ROI. The supply-side platform (SSP): An SSP is in many ways a DSP for the publisher. An SSP assists publishers in managing their ad inventories and selling these inventories on ad exchanges or ad networks through an automated system. Successful connection to an SSP helps drive publisher revenue.

Below we show in their simplest form the DMP, DSP and SSP as they support an ad exchange. As you can see both DSP’s and SSP’s connect to and leverage the data aggregated and analyzed by data management platforms (DMP’s.)

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Figure 22: Major parties involved in the ad exchange

Advertiser Publisher

DSP Ad Exchange SSP Target Audience

Ad network Ad network

DMP DMP

Source: Deutsche Bank

The foundations of a good ad exchange: the network effect An ad exchange is only as strong as the eco-system that surrounds it. The exchange must connect to all major forms of media; including search, display, mobile and video. Access to inventory is also a critical consideration. The more publishers to which an exchange can connect, the wider the array of options an advertiser has to promote its product. While absolute number of publishers is important, the percentage of top sites (as measured by ComScore, Alexa, etc) offers further insight into the quality and profile of available inventory. An exchange that connects to a large number of sites can deliver impressions per day that can reach into the billions or even hundreds of billions. Related to these metrics, an exchange needs to reach as many internet users as possible.

All of these factors lend to an ad exchange’s ability to achieve efficient reach across a desired target audience.

Public and private exchanges

Ad exchanges: public and private. Public dominates with 60% share Having defined the basics of an ad exchange above, we would point out that Public exchanges there are generally two kinds of exchange: public and private. An exchange dominate the market that: seeks to connect on one side a) to a large number of third party websites to advertise on them and b) offer that “inventory” on these third party websites with 60% share to any approved advertisers is a public exchange. An exchange that limits placement of ads to its own property (such as the Tencent Guangdiantong exchange), or to a very select group of websites, is called a private exchange. We estimate that the big public ad exchanges such as Alibaba TANX and Baidu BES capture 60% of programmatic and RTB, with private exchanges and other players representing the balance. We delve into these two different types of exchange in (excruciating) detail later in this report.

A complex landscape: China’s private exchanges The battle for ad budget is not just being waged across Tencent, Alibaba, Baidu and Google’s competing platforms. Tier 1 websites such as Alibaba e- commerce platform Taobao, portal Sina, and video destination Youku (the 3rd, 4th and 22nd most popular destinations on the Chinese internet according to Alexa.com, respectively) have sought to leverage their dominance, sealing off their own inventory by creating Private Marketplaces (PMPs). PMPs in effect allow advertisers to choose websites which they believe to offer quality content while still allowing them to adopt a programmatic approach to purchasing ads. The relative dominance of PMPs means that third party

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exchanges such as Alibaba's TANX and Baidu's BES have less access to this high-end ad inventory, and must access advertising inventory from the long tail, leading to lower quality ad placements.

Tencent Guangdiantong: a private exchange with public characteristics As mentioned above, the private exchange is often built around a single property and thus sells only ad slots on that platform. Youku for instance operates its own private video exchange, selling pre-rolls only on its own platform to a select number of approved customers. Tencent’s Guangdiantong (GDT) to that point is in fact not a public exchange, but a very large private exchange to the extent that the near entirety of its inventory rests on Tencent- owned properties such as desktop Qzone, mobile Weixin public accounts, etc. We have however decided in this report to compare the private GDT and its surrounding eco-system directly to Alibaba, Baidu and Google’s public exchanges.

We offer an illustration of the differences between public and private exchanges. As the figure below indicates, Tencent’s GDT private exchange generally does not place ads on external websites.

Figure 23: Four modes of exchange-based advertising

Span of public exchange

Internal External traffic TANX advertisers owners/publishers Span of private exchange

Internal Internal traffic Alimama, GDT advertisers owners/publishers Ad exchange

External Internal traffic GDT Ad advertisers owners/publishers exchange

External External traffic TANX, BES advertisers owners/publishers

Source: Deutsche Bank

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Obstacles to the adoption of the “trifecta” in China

Concerns that pricing for exclusive high-end inventory will deflate due to RTB While the universal adoption of an extremely automated, efficient and transparent marketplace (similar to the stockmarket) might make eminent sense for many industries, there are many obstacles that lie in the way of broadening application of the ad exchange in China. For one, there will likely always be a discrete market for higher end inventory that both publishers and advertisers would be reluctant to subject to the “great leveler” of real-time bidding. Banner ad slots on a premium website or inventory on a popular mobile application that has an inordinate focus on user engagement are two examples of properties whose ad space will likely be sold in a manual fashion to preserve their premium pricing, ensure thematic consistency with the user environment etc.

TAB and the cannibalization of the offline ad sales force The enabling platforms -Tencent, Alibaba and Baidu-may themselves prove slow in adopting as they must balance these breakthroughs in automation with the interests of their pre-existing direct sales efforts. Worries over the internal cannibalization are in our mind one of the biggest reasons why adoption of these new technologies may continue to proceed slowly.

Viewability, fraud, and transparency Digiday estimates that half of the online ads that sell programmatically are never seen by their intended audiences. Sometimes the problem is that an ad 30-60% of online ad doesn’t load properly or is badly situated on the browser screen. Other times impressions are fake the ads appear on websites that are not relevant to the intended audience.

Digiday also estimates that 30-60% of online ad impressions are fake. Some 36% of all web traffic is generated by botnets, rigged to draw advertisers into buying questionable inventory on phantom sites. Many advertisers surveyed also complain that it is difficult to track the ultimate efficacy of their programmatic ad campaigns. These advertisers seek a clearer view of where their spend is truly going and what it is truly yielding.

The threat of ad-blocking technologies Much has been written about the surge of adoption of ad blocking (or content blocking) technologies, particularly since Apple began approving third-party ad blockers through the release of iOS 9. Ad blockers, which usually come in the form of browser add-on’s, can provide users with cleaner content, faster page download speeds and lower data usage, free of a range of advertisements. This largely user-side capability however should harm ad monetization across the broader industry. The ad exchange itself generally knows not to place an ad through a browser with a blocker installed and active. If a browser has an ad blocker installed, the browser send no information to the ad exchange and so the exchange won't make the space available for purchase.

PageFair for instance estimates that ad block users have risen from 21m monthly active users (MAU) in January of 2010, to 198m as of June, 2015. PageFair estimates that the cost of ad blocker usage to publishers will be nearly USD22b this year, and roughly USD41b in 2016. The concern is that a large number of publishers (especially small scale players) could find it increasingly difficult to continue operations due to lack of advertiser proceeds. We do note, however, that ad blockers have been around for several years. It was likely Apple’s endorsement of them on iOS that stoked the flames of discussion again.

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The good news: it’s only that Apple has joined the ad blocking party Despite the growing hullabaloo around ad blocking, we do note that the only material change that has happened in the space this year is Apple making ad blockers available on iOS. This development theoretically should not interrupt the status quo across the desktop and non-iOS mobile worlds, both of which have had ad blockers for some time.

From one angle, the use of ad blockers effectively suppresses ad supply. We would thus expect ad pricing to rise to accommodate for this. We also would expect non-blockable ad formats to become more popular. As Wordstream.com notes, native ads for instance look, read, and appear just like “true” content, putting them beyond the reach of ad blocking technology. Native advertising has become increasingly popular in recent years, but could soon become even more popular if ad blocker adoption continues to rise.

China awareness of ad blockers relatively low. Ad pricing simply likely to rise should more ads be blocked Unlike the US market, the Chinese masses are not as aware of ad blockers as the public is in the west. While Chinese netizens are likely to embrace ad blocking technologies to the same extent as their western peers, the market’s main internet platforms are themselves in a position to avoid the impact of ad blocker by choosing not to integrate them into their mobile apps. We intend to monitor this issue closely going forward.

Shift in ad exchange-based buying, from RTB to non-RTB programmatic As we show below, exchange-based digital ads buying is a mixture of RTB- based and non-RTB programmatic purchases such as programmatic direct buying, preferred deals, and invitation-only auctions. We expect China’s digital ads budgets to shift steadily toward these non-RTB programmatic methods as advertisers become more and more quality conscious and as a result are willing to pay a higher price for high quality ad space outside the auctions.

Figure 24: Increasing preference for non-RTB programmatic over RTB

100% 0.0% 5.7% 90% 80% 33.7% 39.2% 43.6% 47.2% 70% Non-RTB to represent 60% 47.2% of total 50% 100.0% 94.1% 40% programmatic buying by 30% 66.3% 60.8% 2017E 56.4% 52.8% 20% 10% 0% 2012 2,013 2,014 2015E 2016E 2017E

RTB programmatic Non-RTB programmatic

Source: Deutsche Bank, iResearch

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Summing it up

Figure 25: A glossary enabling ad technologies Participant Definition Examples from China

Ad network Ad networks purchase ad inventories from AdChina publishers and sell them directly to the advertisers or their agents.

Ad exchange Ad exchanges are platforms that facilitate the sale Private: Tencent ad ex; Youku ad of ad space between advertisers and publishers ex; Sina ad ex through a real time bidding process. Public/open: Alibaba TANX; Baidu Exchange Service

Demand side platform DSP's are automated platforms that assist iPinyou, i-Click, Tencent's Tango, advertisers in several ways to enhance the Baidu DSP; Taobao TANX DSP; efficiency and effectiveness of the whole ad Google's Doubleclick bid manager inventory buying process, thereby enabling them to boost the ROI of their advertising budgets.

Supply side platform SSP's assist publishers in managing their ad Baidu SSP; Taobao TANX SSP; inventories and selling these inventories on ad Google's Doubleclick for exchanges or ad networks through an automated publishers system and thereby contribute in enhancing publishers’ revenue.

Data management platform DMP's are automated platforms that accumulate Baidu DMP; Taobao TANX DMP; useful data such as user demographics, search Google's Doubleclick Audience behaviour, preferences, etc from primary as well Center; MediaV DMP as external sources. They act to standardize, categorize, manage, and distribute to relevant parties in the ad exchange platform to make informed decisions.

DSPAN (DSP + Ad network) The DASPAN is unique model adopted in China Qihoo-MediaV that has resulted from combining the key technological features of ad networks and ad exchanges, allowing the coexistence of the two systems without completely replacing ad networks with ad exchanges as is the case in most other developed markets.

Source: Deutsche Bank

As we discussed in the main body of this report, there are generally two kinds of ad exchange structures in operation, the public and private ad exchange. The former, as the name itself suggests, are open to all approved participants, while the latter are closed platforms often serving a set of captive sites. Figure 26 lists out the key differences between these 2 structures along with some examples from China. We note that even though we separate the Chinese ad exchanges into these two different buckets, in reality, it is difficult to draw a

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clear line between private and public platforms. Further, most of China’s private ad exchanges are already gradually moving towards adopting more open structures.

Figure 26: Open/public ad exchanges vs. private ad exchanges Private ad exchanges Public/Open ad exchanges

A closed platform often controlled by a large scale An exchange open for all advertisers, publishers publishers or a group of publishers and open only and other participants to a pre-selected group of participants

Facilitates the proactive sale of inventory to pre- Passive sale of ad inventories to any advertiser selected advertisers who places the highest bid at the auction

The publisher tends to have more control on Publishers have less control compared to a private selling terms such as ability to set up a floor price, exchange type of advertisers eligible to bid, etc.

Mostly used for the exchange of Handles a wide range of inventories of all levels of exclusive/premium quality inventories quality, thus may not be able to charge a preimum price on premium quality inventories

Requires a great level of funding to develop and Significant cost to set up a public ad exchange maintain a private platform. Thus, only large scale media companies have the capacity, thereby limiting entry

Gennerally lack the level of competition witnessed Highly competitive platform with a larger number on an open exchange of advertisers competing against each other

Buyers generally have greater access to seller Buyers often may lack access to in-depth information information about the sellers

Better control against ad fraud Given the great scale of transactions taking place at a given time, keeping a control against ad fraud can prove difficult

More suitable for advertisers in search of and More suitable for advertisers looking for, and publishers possessing, unique and premium ad publishers possessing, small and mostly spaces targeting a higher quality audience undifferentiated inventories on long tail websites

Examples from China: Examples from China: Tencent Guangdiantong (GDT), Youku exchange; Baidu ad exchange; Taobao TANX; Google Sina exchange Doubleclick; Miaozhen exchange

Source: Deutsche Bank

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China internet peer comparison

Figure 27: China internet peer comparison table

Company P/E (x) EV/Sales (x) EV/EBITDA (x) P/S (x) Year Rep. Price Mkt cap RIC ticker DB-rated end ccy (USD) (USDm) 2014 2015E 2016E 2014 2015E 2016E 2014 2015E 2016E 2014 2015E 2016E

China internet Alibaba Group Holding Ltd BABA.K Buy 31-Mar CNY 84.00 203,700 49.5 37.8 32.0 21.0 16.1 12.4 36.2 30.2 23.9 >20 17.4 14.3 Tencent Holdings Ltd 0700.HK Buy 31-Dec CNY 19.91 180,899 35.6 36.7 27.8 9.8 10.5 7.9 21.8 30.0 21.9 10.8 11.6 9.2 Baidu Inc BIDU.OQ Hold 31-Dec CNY 214.11 74,838 29.6 37.0 29.3 7.9 6.4 5.1 23.1 28.0 22.9 8.5 7.1 5.9 Jd.Com Inc JD.O Buy 31-Dec CNY 31.50 37,888 >100 >100 >100 1.4 1.3 0.9 nm nm nm 1.7 1.5 1.1 Vipshop Holdings Ltd VIPS.N Buy 31-Dec USD 16.24 9,446 52.3 29.4 20.6 2.6 1.4 0.9 67.5 28.4 17.1 2.6 1.6 1.1 Netease Inc NTES.OQ Buy 31-Dec CNY 164.44 21,214 12.8 20.7 17.0 3.5 5.5 4.4 8.8 17.3 13.3 5.2 6.8 5.7 Qihoo 360 Technology Co Ltd QIHU.N Not rated 31-Dec USD 67.90 9,021 30.9 19.4 nm nm 6.0 4.7 nm 17.1 nm 8.7 6.1 4.7 Ctrip.Com International Ltd CTRP.OQ Buy 31-Dec CNY 108.85 16,396 61.4 40.8 73.2 5.0 11.0 10.9 70.8 40.9 82.0 6.2 11.8 11.7 Yy Inc YY.OQ Not rated 31-Dec CNY 58.99 3,164 22.8 nm nm 6.4 nm nm 20.2 nm nm 7.0 nm nm Qunar Cayman Islands Ltd QUNR.OQ Buy 31-Dec CNY 44.45 5,820 nm nm >100 10.7 8.6 5.6 nm nm >100 11.3 8.7 5.7 Weibo Corp WB.O Not rated 31-Dec USD 18.60 3,852 nm 71.3 26.2 nm 7.1 5.2 nm 53.3 20.7 nm 8.1 5.8 Jumei International Holding Ltd JMEI.K Not rated 31-Dec USD 8.77 1,330 23.1 10.6 7.1 nm 0.8 0.6 nm 5.8 3.7 nm 1.3 1.0 58.Com Inc WUBA.N Not rated 31-Dec USD 60.21 8,910 nm >100 44.8 nm >20 14.2 nm nm 77.5 nm >20 14.8 Autohome Inc ATHM.N Hold 31-Dec CNY 30.59 3,237 33.3 20.6 17.1 10.6 6.0 4.5 24.0 14.0 10.8 11.9 6.6 5.2 Soufun Holdings Ltd SFUN.n Hold 31-Dec USD 6.83 2,750 19.9 58.8 31.3 6.1 3.2 2.6 13.1 >100 26.6 7.0 3.7 3.1 Youku Tudou Inc YOKU.N Not rated 31-Dec CNY 26.95 2,628 nm nm nm 4.6 nm nm nm nm nm 6.6 nm nm Cheetah Mobile Inc CMCM.K Not rated 31-Dec CNY 19.30 2,577 nm 27.9 11.5 nm 4.2 2.4 nm 22.6 8.3 nm 4.7 2.7 Sina Corp SINA.OQ Not rated 31-Dec USD 51.80 2,482 66.7 nm nm 1.4 nm nm 45.4 nm nm 4.3 nm nm Sohu.Com Inc SOHU.OQ Not rated 31-Dec USD 49.00 1,622 nm nm nm 1.0 nm nm 30.3 nm nm 1.4 nm nm Bitauto Holdings Ltd BITA.K Not rated 31-Dec CNY 26.85 1,648 36.2 9.8 7.0 nm 2.9 2.3 nm 9.9 7.3 nm 3.3 2.6 Renren Inc RENN.N Not rated 31-Dec USD 3.41 842 nm nm nm nm 2.3 nm nm nm nm 3.8 3.1 nm 500.Com Ltd WBAI.N Sell 31-Dec CNY 19.89 700 30.4 nm 76.3 11.5 >20 12.9 41.8 nm nm 12.3 >20 14.3 E Commerce China Dangdang Inc DANG.N Not rated 31-Dec CNY 7.08 573 nm 17.2 nm nm 0.3 nm nm 9.1 nm 0.5 0.4 nm Phoenix New Media Ltd FENG.N Not rated 31-Dec CNY 4.88 344 15.0 nm nm 1.6 nm nm 9.7 nm nm 2.8 nm nm Tuniu Corp TOUR.O Not rated 31-Dec CNY 15.54 1,536 nm nm >100 nm 1.2 0.8 nm nm >100 nm 1.5 0.9 Elong Inc Long.OQ Not rated 31-Dec CNY 17.00 569 >100 20.5 18.7 nm 2.4 1.2 nm 42.2 14.5 2.8 2.4 1.2 Leju Holdings Ltd LEJU.K Not rated 31-Dec USD 5.85 777 nm nm nm nm 0.9 0.8 nm nm nm nm 1.5 1.3 Overall internet average 40.1 36.3 30.5 12.4 10.7 8.4 29.6 29.3 24.9 8.4 11.7 9.6

Source: Deutsche Bank estimate for rated companies; Bloomberg Finance LP for non-rated companies. Note: Data updated based on Dec2nd 2015 closing prices.

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Appendix 1 Important Disclosures

Additional information available upon request

Disclosure checklist Company Ticker Recent price* Disclosure Baidu BIDU.OQ 207.48 (USD) 3 Dec 15 1,2,8 Alibaba BABA.N 82.59 (USD) 3 Dec 15 7,8,14 Tencent 0700.HK 151.10 (HKD) 4 Dec 15 1,14,15 *Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Important Disclosures Required by U.S. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See Important Disclosures Required by Non-US Regulators and Explanatory Notes.

1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees.

2. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company.

7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year.

8. Deutsche Bank and/or its affiliate(s) expects to receive, or intends to seek, compensation for investment banking services from this company in the next three months.

14. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from this company within the past year.

15. This company has been a client of Deutsche Bank Securities Inc. within the past year, during which time it received non-investment banking securities-related services.

Important Disclosures Required by Non-U.S. Regulators Please also refer to disclosures in the Important Disclosures Required by US Regulators and the Explanatory Notes.

1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees.

2. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company.

7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year.

For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr

Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Alan Hellawell III

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Historical recommendations and target price: Baidu (BIDU.OQ) (as of 12/3/2015)

300.00 Previous Recommendations

Strong Buy 250.00 Buy 4 5 6 7 Market Perform 3 8 9 Underperform Not Rated 200.00 1 1112 Suspended Rating 2 10 Current Recommendations 150.00 Buy

Hold Security PriceSecurity 100.00 Sell Not Rated Suspended Rating

50.00 *New Recommendation Structure as of September 9,2002

0.00 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Date

1. 27/02/2014: Hold, Target Price Change USD178.00 7. 30/04/2015: Buy, Target Price Change USD239.00 2. 25/04/2014: Upgrade to Buy, Target Price Change USD229.00 8. 29/06/2015: Buy, Target Price Change USD236.00 3. 25/07/2014: Buy, Target Price Change USD245.00 9. 28/07/2015: Downgrade to Hold, Target Price Change USD206.00 4. 30/10/2014: Buy, Target Price Change USD261.00 10. 08/09/2015: Hold, Target Price Change USD170.00 5. 12/02/2015: Buy, Target Price Change USD249.00 11. 28/10/2015: Hold, Target Price Change USD179.00 6. 14/04/2015: Buy, Target Price Change USD245.00 12. 30/10/2015: Hold, Target Price Change USD189.00

Historical recommendations and target price: Alibaba (BABA.N) (as of 12/3/2015)

140.00 Previous Recommendations

Strong Buy 120.00 Buy 12 Market Perform 3 Underperform 100.00 6 Not Rated 4 5 10 Suspended Rating 9 80.00 7 Current Recommendations 8 Buy 60.00 Hold Security PriceSecurity Sell 40.00 Not Rated Suspended Rating

*New Recommendation Structure 20.00 as of September 9,2002

0.00 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Date

1. 29/10/2014: Upgrade to Buy, Target Price Change USD112.70 6. 08/06/2015: Buy, Target Price Change USD102.00 2. 04/11/2014: Buy, Target Price Change USD112.10 7. 30/08/2015: Buy, Target Price Change USD89.00 3. 29/01/2015: Buy, Target Price Change USD105.10 8. 11/09/2015: Buy, Target Price Change USD85.00 4. 11/03/2015: Buy, Target Price Change USD98.00 9. 27/10/2015: Buy, Target Price Change USD89.00 5. 07/05/2015: Buy, Target Price Change USD104.00 10. 11/11/2015: Buy, Target Price Change USD98.00

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Historical recommendations and target price: Tencent (0700.HK) (as of 12/4/2015)

700.00 Previous Recommendations

Strong Buy 3 600.00 2 Buy 4 Market Perform Underperform 500.00 1 Not Rated Suspended Rating 400.00 Current Recommendations

Buy 300.00 Hold Security PriceSecurity Sell 200.00 11 Not Rated 12 13 14 6 7 8 9 10 Suspended Rating 5 *New Recommendation Structure 100.00 as of September 9,2002

0.00 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Date

1. 10/12/2013: Upgrade to Buy, Target Price Change HKD570.00 8. 12/11/2014: Buy, Target Price Change HKD155.50 2. 20/02/2014: Buy, Target Price Change HKD671.00 9. 12/01/2015: Buy, Target Price Change HKD156.00 3. 19/03/2014: Buy, Target Price Change HKD665.00 10. 18/03/2015: Buy, Target Price Change HKD160.00 4. 14/05/2014: Buy, Target Price Change HKD668.00 11. 13/05/2015: Buy, Target Price Change HKD178.00 5. 19/05/2014: Buy, Target Price Change HKD133.00 12. 12/08/2015: Buy, Target Price Change HKD175.00 6. 13/08/2014: Buy, Target Price Change HKD150.00 13. 15/10/2015: Buy, Target Price Change HKD170.00 7. 03/09/2014: Buy, Target Price Change HKD159.00 14. 10/11/2015: Buy, Target Price Change HKD173.00

Equity rating key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total 500 share-holder return (TSR = percentage change in 450 52 % share price from current price to projected target price 400 350 38 % plus pro-jected dividend yield ) , we recommend that 300 investors buy the stock. 250 200 Sell: Based on a current 12-month view of total share- 150 18 % 11 % holder return, we recommend that investors sell the 100 11 % 14 % 50 stock 0 Hold: We take a neutral view on the stock 12-months Buy Hold Sell out and, based on this time horizon, do not recommend either a Buy or Sell. Companies Covered Cos. w/ Banking Relationship Notes: Asia-Pacific Universe 1. Newly issued research recommendations and target prices always supersede previously published research. 2. Ratings definitions prior to 27 January, 2007 were: Buy: Expected total return (including dividends) of 10% or more over a 12-month period Hold: Expected total return (including dividends) between -10% and 10% over a 12- month period Sell: Expected total return (including dividends)

of -10% or worse over a 12-month period

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Regulatory Disclosures 1.Important Additional Conflict Disclosures Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing. 2.Short-Term Trade Ideas Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.

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Additional Information

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Page 52 Deutsche Bank AG/Hong Kong

David Folkerts-Landau Chief Economist and Global Head of Research

Raj Hindocha Marcel Cassard Steve Pollard Global Chief Operating Officer Global Head Global Head Research FICC Research & Global Macro Economics Equity Research

Michael Spencer Ralf Hoffmann Andreas Neubauer Regional Head Regional Head Regional Head Asia Pacific Research Deutsche Bank Research, Germany Equity Research, Germany

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