China Information Technology 2 August 2016 China Internet Sector ChinaJoy wrap: online games, long may they reign Positive outlook on mobile game revenue growth unchanged; expect recent regulation to accelerate mobile game industry consolidation Tencent and NetEase already dominate respective mobile hard-core John Choi genres in China; both have strong mobile game pipelines in 2H16 (852) 2773 8730 Top picks in the China Internet sector: Alibaba and Tencent [email protected] Alex Liu (852) 2848 4976 [email protected] What's new: We attended ChinaJoy, Asia’s largest digital entertainment fair and World Mobile Game Conference (WMGC), in Shanghai on 29-31 July. We are more optimistic on large online game players including Tencent (700 HK, HKD184.50, Buy [1]) and NetEase (NTES US, USD202.71, Outperform [2]) after the event. We expect both to meet, if not beat, our and the consensus mobile game revenue growth forecasts in their upcoming 2Q16 results. What's the impact: Big players getting bigger. We expect mobile game market consolidation to continue, ultimately benefiting the large players like Tencent and NetEase. Specifically, Tencent plans to launch fewer mobile game titles but with a higher quality to cover the majority of China’s mobile game population. Its leadership in the mobile multiplayer online battle arena (MOBA), casual, and first person shooter (FPS) genres is largely intact, in our view. Separately, we believe NetEase is in a league of its own in terms of the mobile role playing game (RPG) genre in China, and is ready to expand into new genres including Dance and Card & Action. Its PC licence game portfolio, including the recently launched Overwatch and the upcoming WoW 7.0, also look like they would offer good monetisation potential. Tightened regulation favours established players. The State Administration of Press, Publication, Radio, Film and Television’s (国家广电总局) (SARFT) recent requirement for mobile game developers to submit games for review before publishing will greatly increase compliance costs, lengthen the production development cycle and disadvantage small developers. We expect the regulation to lead to an acceleration of mobile game industry consolidation in the next few quarters. Pan-entertainment taking shape. The leading online game companies are all talking about exploiting the value of popular intellectual property (IP) via movies/TV series/literature, etc. In our view, the few players that have control over upstream content production to downstream content distribution will grab the most value from the IP monetisation process. We see Tencent as the best positioned on this front. What we recommend: Within the China online game sector, we believe NetEase and Tencent will continue to harvest the market and gain share at the cost of the smaller players. Our top picks in the China Internet Sector are Tencent and Alibaba (BABA US, USD84.34, Buy [1]). Our long-term positive secular growth thesis on Alibaba still stands. For Baidu, we expect a muted short-term performance given the low visibility on its business recovery and lack of share-price catalysts. How we differ: We are more confident than the street on the secular growth potential for ecommerce and online game players. See important disclosures, including any required research certifications, beginning on page 21 China Internet Sector: 2 August 2016 Internet sector valuations (as of 1 August 2016) Market price Market cap PER (x) P/S (x) EV/EBITDA (x) ROE % Ticker Short Name Rating (local curr') (USDm) FY1E FY2E FY3E FY1E FY2E FY3E FY1E FY2E FY3E FY1E China Internet 700 HK Equity TENCENT Buy 184.50 221,109 32.2 26.3 21.7 10.2 8.3 7.0 20.1 15.9 12.7 37.7 BIDU US Equity BAIDU INC-SP ADR Hold 163.23 57,180 34.9 21.7 15.5 5.2 4.3 3.6 24.2 14.9 9.6 12.2 NTES US Equity NETEASE INC-ADR Outperform 202.71 26,652 15.8 13.9 12.3 4.8 4.0 3.4 10.8 8.9 7.3 33.5 CTRP US Equity CTRIP.COM-ADR Buy 43.09 19,508 149.7 38.8 23.2 6.6 5.3 4.3 n.a. 37.1 18.0 8.5 WB US Equity WEIBO CORP-ADR Non-rated 34.04 7,241 59.9 36.9 23.9 10.9 8.3 6.0 52.0 31.3 16.7 7.4 SINA US Equity SINA CORP Non-rated 54.73 3,823 66.4 37.5 23.8 3.9 3.4 2.9 22.7 14.7 9.3 2.2 YY US Equity YY INC-ADR Non-rated 39.13 2,150 13.6 11.3 n.a. 1.9 1.3 1.1 10.3 8.6 n.a. 34.3 SFUN US Equity SOUFUN HOLDI-ADR Non-rated 5.06 2,405 n.a. 46.0 18.2 1.9 1.5 1.1 n.a. 28.5 15.1 (23.9) ATHM US Equity AUTOHOME INC-ADR Non-rated 22.36 2,564 13.9 11.5 9.5 2.2 1.7 1.1 11.4 8.3 7.3 23.7 EDU US Equity NEW ORIENTAL-ADR Non-rated 43.09 6,762 23.9 19.2 15.5 3.9 3.4 2.9 17.2 13.8 11.4 17.1 BITA US Equity BITAUTO HOLD-ADR Non-rated 28.00 1,690 22.2 14.5 10.5 1.9 2.8 2.3 13.2 8.6 6.5 (7.3) WUBA US Equity 58.COM-ADR Non-rated 51.76 7,328 n.a. 34.2 22.2 5.4 4.2 3.0 58.2 21.0 12.5 (19.3) QUNR US Equity QUNAR CAYMAN-ADR Non-rated 30.00 4,343 n.a. 54.6 23.9 5.4 4.0 2.9 n.a. 84.9 29.6 n.a. XRS US Equity TAL EDUCATIO-ADR Non-rated 58.83 4,758 41.6 27.9 20.5 4.9 3.7 2.8 31.2 20.2 13.8 21.7 SOHU US Equity SOHU.COM INC Non-rated 37.91 1,466 n.a. n.a. n.a. 0.8 0.7 0.7 6.2 2.5 2.1 (3.2) Average 43.1 28.2 18.5 4.7 3.8 3.0 23.1 21.3 12.3 10.3 China E-commerce BABA US Equity ALIBABA GRP-ADR* Buy 84.32 206,626 33.6 26.6 21.0 13.0 9.1 7.2 24.0 18.7 13.7 24.6 JD US Equity JD.COM INC-ADR* Buy 21.84 29,948 n.a. 42.4 19.8 0.8 0.6 0.5 n.a. 46.0 15.2 - VIPS US Equity VIPSHOP HOLDINGS* Buy 14.33 8,257 22.1 17.8 13.7 1.0 0.8 0.7 15.4 10.0 6.9 58.8 JMEI US EQUITY JUMEI INTERNATIO Non-rated 4.08 598 10.1 6.2 5.5 0.4 0.3 0.2 2.8 1.6 1.4 3.4 Average 21.9 23.3 15.0 3.8 2.7 2.2 14.0 19.1 7.8 21.7 Global Internet AAPL US Equity APPLE INC Non-rated 106.05 571,444 12.8 11.8 10.7 2.6 2.5 2.4 6.0 5.8 5.5 37.9 GOOG US Equity ALPHABET INC-C Non-rated 772.88 539,559 22.8 19.3 16.6 6.9 6.5 5.6 12.8 11.0 9.5 15.0 FB US Equity FACEBOOK INC-A Non-rated 124.31 356,935 31.7 24.5 19.8 11.3 9.8 7.3 19.8 14.8 11.7 13.4 AMZN US Equity AMAZON.COM INC Non-rated 767.74 363,965 71.2 47.4 34.7 2.4 2.2 1.8 22.9 17.0 13.4 13.6 PCLN US Equity PRICELINE GROUP Non-rated 1,356.08 67,315 20.3 17.3 15.0 6.2 5.5 4.8 16.7 14.3 12.4 29.3 EBAY US Equity EBAY INC Non-rated 31.25 35,282 16.6 15.1 13.7 3.9 3.8 3.6 10.4 9.9 9.3 14.7 YHOO US Equity YAHOO! INC Non-rated 38.80 36,857 80.0 70.3 65.7 10.4 10.1 10.0 39.8 35.9 34.4 (15.8) TWTR US Equity TWITTER INC Non-rated 16.64 11,777 33.3 29.5 23.0 4.4 4.1 3.6 14.0 11.9 10.0 (9.3) NFLX US Equity NETFLIX INC Non-rated 94.37 40,459 173.2 79.7 45.3 4.1 3.8 3.0 81.3 42.2 25.9 6.3 EXPE US Equity EXPEDIA INC Non-rated 117.37 17,572 23.8 17.8 14.7 1.9 1.8 1.5 12.0 9.6 8.1 5.7 TRIP US Equity TRIPADVISOR INC Non-rated 70.45 10,265 41.6 31.6 24.3 6.3 5.6 4.8 23.0 18.1 14.5 12.3 LNKD US Equity LINKEDIN CORP-A Non-rated 193.09 26,014 56.0 44.7 35.5 6.7 5.8 4.9 23.8 19.2 15.5 (4.0) 035720 KS Equity KAKAO CORP Buy 91,000.00 5,540 21.5 21.0 19.1 4.9 3.7 3.3 14.5 11.6 10.2 10.2 4755 JP Equity RAKUTEN INC Non-rated 1,184.00 16,627 25.7 19.9 16.1 2.1 0.0 0.0 2.3 1.9 1.6 7.8 4689 JP Equity YAHOO JAPAN CORP Non-rated 446.00 24,975 19.0 17.1 14.9 2.9 3.3 3.1 9.3 8.4 7.6 22.6 Average 43.3 31.1 24.6 5.1 4.6 4.0 20.6 15.4 12.6 10.6 Source: Bloomberg, *Daiwa forecasts 2 China Internet Sector: 2 August 2016 Table of contents Tencent: highlights from ChinaJoy .......................................................................