SYNC. - Google vs. Baidu - Inside

SYNC. - Google vs. Baidu - Inside

High quality research requires investment Please do not copy or forward © CM Research 2012 SYNC. Global investment themes: telecoms, media and technology Issue No. 41 Google vs. Baidu 22 February 2012 Inside  Internet advertising  Social media threat  Google model  Baidu model Recent TMT themes  Mobile bandwidth  Patent wars  The app Internet  HTML5  Emerging Mobile OS  Quad-core processors  Global slowdown scenario  App revolution  Music, video, social  Cyber security  Video games  Mobile payments  Chinese Internet  Regulation  Cloud computing Internet search is big business The global internet advertising market is worth $81bn and is growing at 15% per annum. Internet search accounts for 45% of all global internet advertising. Display ads account for 51% and mobile ads for the remaining 4%. The US is the world’s largest internet advertising market by value – accounting for 38% of all internet advertising – but China is the largest by users – it has 520m internet users – and the fastest growing. Today, China accounts for 5.0% of the global internet display advertising market, but 7.0% of the global internet search market. That makes the Chinese comparatively better at monetising search than other internet activities such as video. Through internet search, both the US and China have created two technology titans. Google’s market capitalisation of $196bn makes it the fourth largest technology company in the world. Baidu, with a market cap of $48bn, is the largest technology company in China after China Mobile. Both make their money from internet search, but one is valued as a growth stock whilst the other is out of favour.

Google vs. Baidu: justifying their valuations In this report we perform a reasonableness test on Google’s and Baidu’s market valuations. We conclude that, in order to justify current market valuations, Baidu’s revenues will have to grow at very aggressive rates. In 2011, Baidu’s revenues grew by 80%; by 2015 they will need to grow by 37% and, even by 2020, at 19%. Moreover, our calculations also imply that Baidu’s revenues in 2020 will be equivalent to 109% of the Chinese internet advertising market. That means that in order to justify its valuation, Baidu must expand overseas. By contrast, our models imply that Google’s revenue growth can slow considerably – from 29% in 2011 to about 6% by 2020 – and still generate sufficient free cash flows to justify its current market valuation. In other words, Google has a lot of scope to surprise on the upside and Baidu a lot of scope to disappoint. This conclusion may well prove to be correct in the long term. But for now, Baidu, as the established market leader, is likely to go from strength to strength given its protected position in the world’s fastest growing internet market. It could easily have another three or four consensus- beating quarters before growth starts to slow.

Social media threat Whereas internet search engines seek growth by using their dominance in search advertising to springboard into the display advertising market, social networks do so the other way around. In the US, Facebook now has a 16% share of the world’s largest display advertising market. As social networks attract more eyeballs, they suck in more advertising dollars. Soon they will invent ‘social search engines’ of their own that advertisers might find more valuable. In the short term, Google faces the greater risk. Facebook’s 850m users are already generating a 47% operating profit for the company, whilst Renren, Baidu’s main social network threat, has slipped back into loss. Cyrus Mewawalla cyrus@researchcm.com +44 (0) 20 3393 3866 www.researchcm.com

SYNC, Issue 41 22 February 2012 www.researchcm.com 2 Introduction In this report we look at the two most important internet markets: the US, which is currently the largest by value and the most innovative; and China, which is the largest by users and the fastest growing. Both internet markets have produced national champions: one has already gone global; the other may soon follow. How much are the world’s two biggest internet search engines – Google and Baidu – really worth? What risks do their investors face? And how might their competitive landscape change in the future?

The global internet advertising market By 2015, internet advertising will account for a fifth of all advertising In 2011, the global advertising market was worth around $475bn. Television advertising was the biggest part, contributing $175bn and accounting for 37% of the total. Last year, the internet advertising market was worth $81bn and accounted for 17% of all global advertising. Globally, internet advertising revenues grew at an annual rate of about 15% between 2006 and 2011. During that period the overall advertising market remained flat. Consequently, as a share of global advertising revenues, internet advertising has grown from 8% in 2006 to 17% in 2011 and should reach 22% by 2015.

Internet search accounts for half of all internet advertising Within this $81bn global internet advertising market, about 45% of revenues are generated from internet search, 51% from display advertising and the remaining 4% from mobile devices. For Google and Baidu, who dominate the search industry, growth is likely to come from expansion into the mobile, video and display advertising markets. But, social networks like Facebook are beating them to it. In 2011, social networks accounted for 14% of all display advertising revenues. By 2014, that could rise to 23%. Internet advertising is the fastest growing element of the global advertising market Between 2006 and 2001, internet advertising’s share of global advertising grew from 8% to 17%; by 2015 it will be 22% Source: Informa, PwC, eMarketer, CM Research For search engines like Google and Baidu, it is imperative to conquer the display advertising market Display ads account for 51% of all internet advertising … … but social networks are eating into this market Source: Informa, PwC, eMarketer, IDC, CM Research Global Media Model ‐ 100,000 200,000 300,000 400,000 500,000 600,000 700,000 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 $m Global advertising market Other Internet TV Search 45.0% Display 50.6% Mobile 4.5% 2011 Global internetadvertising market ($81bn) ‐ 10,000 20,000 30,000 40,000 50,000 60,000 2009 2010 2011 2012 2013 $m Globaldisplay advertising market Social networks Otherdisplay

SYNC, Issue 41 22 February 2012 www.researchcm.com 3 The US and Chinese internet advertising markets China has been relatively poor at monetising internet traffic… Compared to the US, Japan and Western Europe, China is inefficient at converting internet traffic into internet advertising revenues. China accounts for 10.6% of global consumer IP traffic, but only 6% of global Internet advertising expenditure. In other words, Chinese consumers use the Internet more, but spend far less than everyone else per gigabyte of traffic generated.

… but relatively strong at monetising internet search However, China is exceptionally strong at monetising internet search. Whilst China only accounts for 5.0% of the global internet display advertising market, it accounts for 7.0% of the global internet search market. China’s internet advertising market is growing three times as fast as America’s China’s internet advertising market has two growth drivers. The first is GDP. As the chart on the following page illustrates, China spends about 0.08% of its GDP on internet advertising. The comparative figure for the US is 0.21%. For Japan, the percentage is 0.19%. In Korea it is 0.17%. As per capita incomes grow, so will this figure. At about $5,000, China’s per capita incomes are about a ninth of the levels in the US, but growing at a real rate of around 8% per annum compared to something like 1% in the US.

Chinese Internet companies have a poor record of monetising internet traffic… China accounts for 10.6% of global IP traffic… but only 5.7% of global internet advertising revenues Source: Cisco, eMarketer, Informa, PwC, CM Research Global Media Model Chinese internet companies are highly successful at monetising internet search In 2011, China accounted for just 5.0% of the global internet display advertising market, worth $41bn… .. but 7.0% of the global internet search advertising market, which was worth $37bn Source: PwC North America 28.2% Western Europe 24.6% CEE 3.8% Asia (ex Japan, China) 23.4% Lat Am 4.2% Japan 5.3% China 10.6% Global Consumer IP traffic 2011 North America 40.6% W Europe 29.1% CEMEA 3.7% Asia (ex‐ Japan, China) 6.3% Lat Am 1.7% Japan 12.9% China 5.7% 2011 Internet advertising market, $81bn USA 39.6% W Europe 28.5% Japan 13.2% China 5.0% Korea 0.9% Brazil 0.7% Rest of World 12.1% 2011 internet display ad market ($41bn) USA 36.6% W Europe 31.1% Japan 9.9% China 7.0% Korea 2.3% Brazil 1.5% Rest of World 11.5% 2011 internet searchmarket ($37bn)

SYNC, Issue 41 22 February 2012 www.researchcm.com 4 The second growth driver for the Chinese internet is mobile broadband. China now has 520m internet users and 950m mobile subscribers. By the end of the year, around half of those mobile subscribers could have mobile broadband. China’s internet advertising market is growing 3x as fast as its western counterparts At $4.6bn, China’s internet advertising market is the fifth largest in the world after the US, Japan, UK and Germany. It is growing three times as fast as western markets – whilst the US and Western Europe are seeing their internet adverting markets grow at 12% to 14% per annum, China’s is growing at 35%. As a percentage of GDP, China’s internet advertising market remains well below the world average China spends 0.08% of its GDP on internet advertising – the world average is 0.11% Source: IMF, Informa, PwC, CM Research China’s internet user community is still growing and half will have mobile broadband by the year end In 2007, China became the biggest internet market by users Internet users By year end, most Chinese internet users will have 3G 3G handsets as % of total shipments Source: CM Research Global Telecom Model In 2011, the US internet advertising market was worth $31.1bn while China’s was worth $4.6bn US internet advertising revenues are growing at 14%... While China’s are growing at 35% Source: Informa, PwC, eMarketer, CM Research 0.0% 0.1% 0.2% 0.3% 0.4% 2011 Internet advertising expenditure as a percentage of GDP 100 200 300 400 500 600 700 2005 2006 2007 2008 2009 2010 2011 2012 Western Europe USA China India 0% 20% 40% 60% 80% 100% 120% 2005 2006 2007 2008 2009 2010 2011 2012 Western Europe North America China India ‐ 10,000 20,000 30,000 40,000 50,000 2005 2007 2009 2011 2013 2015 $m Internet advertising market USA Search USA Display USA Mobile ads ‐ 2,000 4,000 6,000 8,000 10,000 12,000 2005 2007 2009 2011 2013 2015 $m Internet advertising market ChinaSearch ChinaDisplay ChinaMobile ads

SYNC, Issue 41 22 February 2012 www.researchcm.com 5 Google vs. Baidu Both are established market leaders… Both Google and Baidu have risen by becoming the established leaders in their domestic search markets. Google has a 66% market share of US internet searches and Baidu a 78% market share of Chinese searches. Both are also moving aggressively into the display advertising markets – Google, for example, already has 12.6% of the US internet display advertising market. These trends are reflected in the charts below. In 2011, Google generated 56% of all internet advertising revenues in the US and Baidu 51% of all internet advertising revenues in China.

Whilst Baidu is currently a China-only play, Google is more global – over half of Google’s revenues are generated overseas. … and both face threats from social networks Many social networkers spend more time inside their social network than doing any other single activity on the internet – in the US one seventh of all time spent on the internet is on Facebook. Much of the action takes place inside a walled garden. Search engines are usually not allowed in. That means, once they reach critical mass, social networks can corner the market for display advertising. As they get bigger, social networks become an internet within the internet – take that theory to the extreme and internet search engines would have little value without access to the big social networks … access they would have to pay for. Both Google and Baidu account for half their domestic internet advertising markets by revenues In 2011, Google held 56% revenue share of the US internet advertising market Baidu held a 51% revenue share of the Chinese internet advertising market Source: CM Research Global Media Model Today, social networks pose a far bigger threat to Google than to Baidu Facebook’s social network of almost 900m users is a direct threat to Google. Renren is also a threat to Baidu No. of users But whilst Facebook is already making 47% operating margins, Renren is loss-making Operating margins Source: Company data, Reuters, CM Research Global Media Model ‐ 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 2005 2006 2007 2008 2009 2010 2011 2012 $m US internet advertising revenues Others Facebook Microsoft Yahoo Google ‐ 1,000 2,000 3,000 4,000 5,000 6,000 7,000 2005 2006 2007 2008 2009 2010 2011 2012 $m Chinese internet advertising revenues Others Renren Sina Tencent Baidu ‐ 100 200 300 400 500 600 700 800 900 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Facebook Renren -80% -60% -40% -20% 0% 20% 40% 60% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Baidu Google Facebook Renren

SYNC, Issue 41 22 February 2012 www.researchcm.com 6 … but only one of them is valued as a growth stock Baidu currently trades at 30 times 2012 earnings forecasts, far higher than Google’s forward P/E multiple of 14. On price to sales multiples, Baidu trades at 21x relative to Google’s 5x. As the table below shows, Baidu is one of the most highly rated Chinese internet stocks. By contrast, Google – together with Apple – is valued almost as an ex-growth stock. Are these valuations reasonable? Sync thought it would be useful to work out what their current market valuations implied for Google’s and Baidu’s respective market share forecasts in the global internet advertising market. So we made sensible projections for the global internet advertising sector – mostly in line with leading industry commentators such as Informa, PwC, IDC and eMarketer. Then, for each company, we calculated how fast their revenue line in their DCF models would have to grow to justify their current valuations. Finally, we translated those revenue estimates into market share expectations and reviewed them for reasonableness. Here are our market assumptions We made the following assumptions about the global internet advertising market:  Global internet advertising revenues will see growth rates slow from 14% in 2011 to 8% by 2020  China’s share of the global market will grow from 5.7% in 2011 to 14.4% by 2021  America’s share of the global market will fall from 38% to 33% in that period Baidu is highly rated by the market whilst Google is valued as an ex-growth stock Valuation tables Source: Company data, FT, S&P, CM Research Company Description Mkt Cap P/E P/Sales Op margin US$m % % Google internet search engine 195,835 14.2 5.2 31.0 Baidu internet search engine 47,797 29.6 20.7 52.2 Top US internet peers Apple World's largest consumer electronics company 468,162 11.8 3.6 31.2 Amazon online retailer 83,050 74.8 1.7 1.8 eBay online auction house 45,119 15.3 3.9 20.4 Priceline online travel agency 29,000 25.1 7.0 25.5 Yahoo! portal 18,617 17.8 3.8 16.5 Groupon social shopping site offering group discounts 13,028 80.4 2.9 -12.8 Linkedin Business netw orking site 9,200 141.0 13.2 4.9 Zynga social games developer 9,043 49.9 3.7 -35.6 Netflix Internet video streaming service 6,753 326.0 2.0 12.0 Mean 82.5 4.7 7.1 Median 49.9 3.7 12.0 Top Chinese internet peers Tencent Chinese portal w ith leading IM platform 45,938 27.6 12.0 48.9 Netease MMORPG games (e.g. Westw ard Journey) 6,220 10.6 5.5 45.6 Alibaba e-commerce platform 5,966 19.6 5.9 28.3 Sina Chinese portal w ith leading microblog platform 4,465 73.6 9.5 23.9 Ctrip online travel agency 3,363 15.7 3.6 Renren China's leading social netw ork (China's Facebook) 2,862 201.0 #N/A N/A 11.0 Youku.Com China's version of YouTube 2,446 #N/A N/A 15.1 -39.8 Qihoo 360 Chinese cyber security company 2,086 36.9 #N/A N/A 15.6 Sohu Chinese multi media portal 1,915 13.3 2.3 33.1 Mean 49.8 7.7 18.5 Median 23.6 5.9 23.9

SYNC, Issue 41 22 February 2012 www.researchcm.com 7 Now, here are our company assumptions:  EBITDA margins: both companies will see margins converge to 36% (Google’s current margins) by 2022 as competition bites  Capex: both companies will continue to spend around 9% of revenues on Capex  Tax: both companies will continue to pay tax at their existing effective rates of 21% for Google and 15% for Baidu  WACC: We use a weighted average cost of capital of 11% for Google and 14.5% for Baidu – reflecting a higher risk free rate for China and a higher beta for Chinese internet stocks  Terminal growth rate: We use a terminal growth rate of 4% for both companies  Motorola acquisition: We do not model Motorola’s hardware business in Google’s DCF valuation How fast do Google’s revenues have to grow to justify its current valuation? Taking all these assumptions into account, the DCF model below shows that, in order to justify Google’s current valuation, Google’s revenue growth will slow considerably – from 29% in 2011 to about 6% by 2020. Our assumptions for the internet advertising market are that … … the global internet advertising market sees annual growth rates slow from 14% in 2011 to 8% by 2020 Global internet advertising market … and China’s share of the global market grows from 5.7% in 2011 to 14.4% by 2021 Market shares: global internet advertising market Source: Informa, PwC, CM Research Global Media Model What does Google’s discounted cash flow model imply for its top line growth Our discounted cash flow model justifies the current market valuation Source: Company data, CM Research 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50,000 100,000 150,000 200,000 250,000 2006 2008 2010 2012 2014 2016 2018 2020 Global market revenues ($m) Global market growth (%) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2005 2010 2015 2020 Restof World LatAm China Japan Asia(ex‐Japan,China) WEurope USA $m 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Terminal GOOGLE GOOG GOOGGOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOGLGOOGLE Revenue 23,651 29,321 37,905 44,293 49,975 55,982 62,236 68,633 75,041 81,305 87,247 92,683 96,378 99,392 100,357 Growth rate 9% 24% 29% 17% 13% 12% 11% 10% 9% 8% 7% 6% 4% 3% 1% EBITDA 9,836 11,777 13,593 15,852 17,850 19,955 22,140 24,366 26,587 28,748 30,787 32,638 33,870 34,858 35,125 EBITDA (%) 42% 40% 36% 36% 36% 36% 36% 36% 35% 35% 35% 35% 35% 35% 35% Less CAPEX -810 -4,018 -3,438 -4,055 -4,617 -5,220 -5,855 -6,515 -7,187 -7,856 -8,503 -9,112 -9,556 -9,939 -10,036 Less TAX -1,861 -2,291 -2,855 -3,330 -3,749 -4,191 -4,650 -5,118 -5,585 -6,038 -6,467 -6,855 -7,114 -7,322 -7,378 FCF 7,165 5,468 7,300 8,468 9,483 10,544 11,634 12,733 13,816 14,854 15,817 16,671 17,200 17,597 17,711 247,712 PV 7,618 7,676 7,678 7,622 7,506 7,327 7,087 6,790 6,439 5,976 5,501 77,220 7,618 15,294 22,973 30,595 38,101 45,428 52,515 59,305 65,743 71,719 77,220 Terminal value 77,436 Enterprise Value 154,657 Less: Net debt/(cash) -41,212 Fair value of the equity 195,869 Assumptions Capex/sales ratio: 9% Terminal growth rate: 4% Effective tax rate 21% WACC: 11%

SYNC, Issue 41 22 February 2012 www.researchcm.com 8 How fast do Baidu’s revenues have to grow to justify its current valuation? Taking all these assumptions into account, the DCF model below shows that, in order to justify Baidu’s current valuation, Baidu’s revenues will have to continue to grow at very aggressive rates. In 2011, Baidu’s revenues grew by 80%; by 2015 they will need to grow by 37% and even by 2020 top line growth will need to be 19%. Investment implications On the face of it, our DCF exercise implies that Google has a lot of scope to surprise on the upside and Baidu a lot of scope to disappoint. This conclusion may well prove to be correct in the long term. But, for now, Baidu, as the established market leader, is likely to go from strength to strength given its protected position in the world’s fastest growing internet market. The Chinese internet search champion could easily have another three or four consensus-beating quarters before growth starts to slow.

Market share implications Our DCF workings imply that Baidu’s share of the global internet advertising market will increase from 2.9% in 2011 to 15.5% by 2020. During that period, Google’s market share – on the basis of the above DCF assumptions – will fall from 47% to 43% Our DCF calculations also imply that Baidu’s revenues in 2020 will be equivalent to 109% of the Chinese internet advertising market. That means that in order to justify its valuation, Baidu must expand overseas. What does Baidu’s DCF model imply for its top line growth?

Our discounted cash flow model justifies the current market valuation Source: Company data, CM Research At current valuations, our DCF models imply that Baidu’s global market share will grow fivefold from 3% to 16% by 2020 while Google’s will fall from 47% to 43% Source: CM Research Global Media Model $m 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Terminal BAIDU BAIDU BAIDUBAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU BAIDU IBAIDU Revenue 706 1,256 2,300 3,510 5,089 8,080 11,096 14,635 18,703 23,278 28,314 33,730 38,992 44,382 47,669 39% 78% 83% 53% 45% 59% 37% 32% 28% 24% 22% 19% 16% 14% 7% EBITDA 255 628 1,173 1,752 2,485 3,858 5,178 6,671 8,323 10,107 11,986 13,914 15,662 17,346 18,114 15 14 13 12 11 10 9 8 7 6 5 4 3 2 EBITDA (%) 36% 50% 51% 50% 49% 48% 47% 46% 45% 43% 42% 41% 40% 39% 38% Less CAPEX -69 -150 -207 -319 -467 -749 -1,039 -1,384 -1,785 -2,243 -2,754 -3,312 -3,864 -4,438 -4,767 Less TAX -31 -84 -179 -267 -378 -587 -788 -1,016 -1,267 -1,539 -1,825 -2,118 -2,384 -2,641 -2,758 FCF 155 394 788 1,166 1,640 2,522 3,351 4,272 5,270 6,325 7,407 8,484 9,414 10,267 10,590 102,164 PV 1,020 1,254 1,686 1,959 2,184 2,355 2,472 2,531 2,535 2,459 2,345 22,799 1,020 2,273 3,959 5,918 8,101 10,457 12,929 15,460 17,994 20,454 22,799 Terminal value 23,338 Enterprise Value 46,137 Less: Net debt/(cash) -1,822 Fair value of the equity 47,959 Assumptions Capex/sales ratio: 9% Terminal growth rate: 4% Effective tax rate 15% WACC: 14% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Market shares: globalinternet advertisingmarket Other Facebook Baidu Microsoft Yahoo Google

SYNC, Issue 41 22 February 2012 www.researchcm.com 9 Risks Let’s finish by reminding ourselves of the main risks that investors in Google and Baidu face. Execution risk: mobile sector Both Baidu and Google want to move from the fixed line sector into mobile search. Both have run into problems. Google’s recent results showed a dramatic fall in average revenues per click as investors discovered that advertisers are paying less to advertise on mobile. Its mobile strategy is failing because the mobile search market – which accounted for just 4.5% of all internet advertising in 2011 – is simply not growing fast enough. Baidu’s move into mobile is not as assured as investors might have expected. Its market share in mobile search is about 30%, much lower than its 80% share in Chinese internet search, with its main mobile competitor Easou likely to list in the near future.

Execution risk: threat from social media sector Whereas internet search engines seek growth by using their dominance in search advertising to springboard into the display advertising market, social networks do so the other way around. In the US, Facebook now has a 16% share of the world’s largest display advertising market. As social networks attract more eyeballs, they suck in more advertising dollars. Soon they will invent ‘social search engines’ of their own that advertisers might find more valuable than internet search engines. In the short term, Google faces the greater risk. As the charts on page 5 show, Facebook’s 850m user base is still growing and the social network is already generating a 47% operating profit, whilst Renren, Baidu’s main social network threat has seen user growth slow and has slipped back into loss.

M&A risk Google’s biggest strategic risk is the post-merger integration of Motorola Mobility. Google’s management have little experience of running a hardware company. Moreover, investors will face a psychological shock when Motorola’s results are fully consolidated: Google’s group P&L account will show a deterioration in margins – Motorola’s operating margins are closer to zero than to Google’s 36% margins in search. Political risk Whilst Baidu’s political connections are likely to help it consolidate its leading market position in China, Google is likely to remain excluded from the world’s fastest growing internet market for some time. Even Facebook, in its recent IPO prospectus said it was “unsure” it would enter China given the difficulties of reconciling its own position with that of the Chinese government. The question on everyone’s mind is how the US government will react when Baidu wants to set up shop in America.

Tax risk Google is alleged to have dodged $3bn in tax receipts over the last three years by channelling its revenues through a complex web of tax havens. Its effective tax rate of 21% is low for a US company. There is a risk that its effective tax rate will rise substantially if governments all around the world decide that the US search engine is not paying sufficient taxes on profits made in their domestic markets. Baidu’s effective tax rate of 15% also appears to be low and that may change under China’s new political leadership later in 2012. Corporate governance risk The greatest risk for investors in China is corporate governance risk. The “varied interest entity” (VIE) is common in China’s technology, media and telecom sectors. Under a typical VIE structure, the owners of a Chinese internet company register a shell company in a tax haven like the Cayman Islands. This off-shore holding company then sets up service contracts to run the operating assets held by wholly owned subsidiaries in China and is entitled to the economic benefits those assets generate. That means that investors who own stocks like Baidu do not actually own the underlying operating assets within their group businesses. It is this corporate governance weakness that has been the main cause of the long-running dispute between the management of Alibaba Group and Yahoo, a 40% shareholder in Alibaba Group, over who owns the group’s various operating assets.

Misinformation risk Chinese internet companies face less third party scrutiny of their internet statistics than their western counterparts. Many do not allow leading data gatherers like Alexa or Comscore access to their sites. The absence of reliable industry statistics could lead to profit warnings in future and give short selling research houses like Muddy Waters more scope to manipulate share prices. In the short term, investors run the risk of basing investment decisions on highly questionable data.

SYNC, Issue 41 22 February 2012 www.researchcm.com 10 About CM Research CM Research is an independent research provider with a blue chip list of institutional clients. We analyse emerging trends and develop them into global investment themes. At a time when many of our competitors have had their reputations mired by conflicts of interest, we fiercely guard our independence. We have two thematic research products. Sync summarises our latest investment themes in the technology, media and telecom sectors. Strategy Economics summarises our latest investment themes in the global macro space. Our business model is based on independence, exclusivity and experience. Our research is not freely available. This makes it more valuable.

Contact CM Research Sync Strategy Economics Technology, media & telecom Macro Cyrus Mewawalla Matthew Lynn cyrus@researchcm.com matthew@researchcm.com Office: 22 Upper Grosvenor Street, London W1K 7PE Tel: +44 20 3393 3866 Web: www.researchcm.com Important Disclosures This document is issued by CM Research (“CMR”) solely for our clients. This document may not be reproduced, redistributed or passed to any other person in whole or in part for any purpose without our written consent. This document is provided for information purposes only and should not be regarded as an offer or solicitation for the subscription, purchase or sale of any security or other financial instrument mentioned herein. All expressions of opinions and estimates constitute a judgement and, unless otherwise stated, are those of the author and the research department of CMR only, and are subject to change without notice. CMR is under no obligation to update the information contained herein. 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© CM Research 2012. All rights reserved. Analysts’ Certification The analysts involved in the production of this document hereby certify that the views expressed in this document accurately reflect their personal views about the securities mentioned herein. The analysts point out that they may buy, sell or already have taken positions in the securities, and related financial instruments, mentioned in this document.

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