Executive summary
Outlook – High growth with moderating risk profile
We believe the China online gaming industry is a serious sector with broadening appeal. It
has come of age, surpassing Korea as Asia’s biggest online gaming market by revenue. We
believe the sector has hit its stride with a number of recent successful IPOs and will continue
to grow (at a 30%+ CAGR to US$2.62bn in 2010) but with a moderating risk profile. Key
developments include:
􀂄 Advent of FTP (“free-to-play” billing model), and richer and wider product offerings
will capture a broader Internet population
􀂄 Vertical integration, multi-sourcing game strategies and innovative monetization
of game "community" concept development trends to lead to additional revenue
streams beyond traditional game licensing operations
􀂄 Favorable macro trends like China Internet and GDP per capita growth provide
additional drivers to gamer and APRU (average revenue per user) growth
Due to a favorable industry outlook, the number of listed Chinese game companies have
doubled to 8 this past year, further intensifying competition. Our industry research leads us to
believe that game operators can stand out in the crowd because they:
􀂄 Have articulated clear strategies of diversification.
􀂄 Boast in-house development capabilities to strike a hybrid game sourcing approach.
􀂄 Have demonstrated management foresight and some unique “edge” in the industry.
Shanda is our top pick in the sector based on a formula of quality and depth of its current
game portfolio and pipeline, R&D capability, revenue diversification, profitability and strategic
clarity.
Valuation
In our view, utilizing a forward PE valuation method to look at Chinese online gaming
companies is appropriate as it better captures near-term growth potential, and the industry as
a whole is profitable making PE relevant. Despite improving earnings sustainability, we
utilized DCF and PEG only as a sanity check given that the industry's growth outlook is largely
driven by 12~18 months of game pipeline visibility. The "hit-or-miss" upside/downside risk
persists, rendering the valuation of these companies from a LT perspective all the more
difficult. Due to differences in industry development, regulation, distribution models and
gamer population, we believe for the time being that a cross-country valuation comparison is
inappropriate. We have thus conservatively applied only the Chinese online gaming sector PE
average of 15.9x (represented by the more established online gaming companies such as
Shanda, The9, NetEase and Perfect World) as a basis for valuing individual gaming
companies.
Our target prices are as follows: Shanda (SNDA.OQ, US$36.24, Buy, TP US$43), Kingsoft
(3888.HK, HKD4.19, Buy, TP HKD4.95), The9 (NCTY.OQ, US$23.83, Hold, TP US$25) and
NetEase (NTES.OQ, US$20.70, Hold, TP US$19.50).
Risks
We believe the main downside risks pertinent to this sector are: 1) further negative
government policies curbing online game play, 2) increasing competition for the industry,
which may cause price erosion, 3) the “hit-or-miss” scenario associated with online gaming
companies can still have material impact on gaming operators and competition from other
forms of entertainment. In addition, for our two Hold-rated stocks, the upside risks are
potential blockbuster titles in pipeline and better control of operational expenses.

Table of Contents
Executive summary ........................................................................... 3
Outlook – High growth with moderating risk profile .................................................................3
Valuation ..................................................................................................................................3
Risks ........................................................................................................................................3
Industry overview.............................................................................. 4
Less volatile but high-growth....................................................................................................4
China online gaming under the microscope ................................... 7
Jockeying for gamer attention ..................................................................................................7
“Free-to-play/pay-for-item” (FTP or item-based) model here to stay….....................................8
What business model to pursue: In-house development? Hybrid? Game licensing? ...............9
Casual games growth (35% CAGR) to outpace MMORPG (26% CAGR) ...............................11
From “gaming operators” to “community operators” ...........................................................12
3D games have become mainstream .....................................................................................13
The much-talked-about anti-fatigue regulation….....................................................................14
Valuation .......................................................................................... 16
Initiate Overweight on Chinese online gaming sector ............................................................16
Risks.................................................................................................. 19
What’s driving China’s online gaming industry? .......................... 20
IDC forecasts that China online games market will see a 07-10 CAGR of 28.7%...................20
So who has the top games? ........................................................... 25
The top games in China ..........................................................................................................25
Competitive landscape analysis..................................................... 27
Intensifying competition from cash-rich upstarts....................................................................27
Leading game operators’ comparison and profile...................................................................28
Shanda ...................................................................................................................................29
NetEase .................................................................................................................................30
The9.......................................................................................................................................31
Kingsoft..................................................................................................................................32
Giant Interactive (ZTGame)......................................................................................................33
NetDragon ..............................................................................................................................33
Perfect World..........................................................................................................................34
Sohu.......................................................................................................................................35
Tencent ..................................................................................................................................35
Appendix A....................................................................................... 37
Industry chain and value chain ................................................................................................37
2 main types of game payment model ...................................................................................37
What are the types of online games? .....................................................................................38
Gamer preferences according to recent IDC survey...............................................................38
Sample game ranking from multiple sources..........................................................................39
Online gaming dictionary ........................................................................................................43
Shanda.............................................................................................. 45
Kingsoft ............................................................................................ 56
The9 .................................................................................................. 75
Netease.com .................................................................................... 85