China Internet Sector
Long-term positive but short-term cautious
􀂄 Consumption slowdown could spread inland
We believe the long-term growth outlook for China’s Internet sector remains
promising based on a low penetration rate and ample potential in the rural market.
However, we are cautious about the next two years as the macro slowdown, which
has dragged down consumption in the eastern coastal areas, could spread inland.
􀂄 We prefer the online games sub-sector
We believe revenues generated from consumers (games) are more defensive than
SMEs (search and B2B) during the economic slowdown. In the short term, we
prefer time-based (NetEase) over item-based games with a high revenue
concentration (Giant Interactive). We think pure games companies with diversified
business models are due for a re-rating (Shanda Interactive is our top pick), as we
think they have long-term sustainability.
􀂄 Portals more defensive than online search
We are cautious about overall ad spend in China in 2009. Online ads have proved
to be more volatile than traditional media. Within the online ad space, we believe
portals (Sohu.com) are more defensive than online search (Baidu.com), as we
expect SME ad spend to be adversely impacted by the macro slowdown.
􀂄 We initiate coverage of:
NetEase with a Buy rating and a US$37.00 price target; Sohu.com with a Buy
rating and a US$70.00 price target; Baidu with a Sell rating and a US$150 price
target; and Alibaba with a Sell rating and a price target of HK$6.00. We maintain
our Neutral rating on Giant Interactive and raise our price target from US$6.77 to
US$7.80.

Contents page
Key investment themes 3
Assessing the Chinese Internet market 10
Online games sector 23
Risk and business models 33
Valuation and stock picks 35
Understanding online games in China 38
Online advertising: portal vs. search engine 42
Near-term headwinds for B2B 57
Online shopping: fastest growth within the Internet space 65
Company pages 71
— Shanda Interactive Entertainment ......................................................................72
— Investment Thesis........................................................................................73
— Key catalyst ...........................................................................................74
— Risks .....................................................................................................74
— Valuation and basis for our price target..................................................74
— UBS vs. consensus................................................................................74
— Sensitivity ..............................................................................................75
— NetEase.com .....................................................................................................89
— Investment Thesis........................................................................................90
— Key catalysts .........................................................................................90
— Risks .....................................................................................................90
— Valuation and basis for our price target..................................................91
— UBS vs. consensus................................................................................91
— Sensitivity ..............................................................................................92
— Financials ....................................................................................................98
— Tencent Holdings .............................................................................................107
— Giant Interactive Group ....................................................................................113
— Sohu.com Inc. ..................................................................................................118
— Investment Thesis......................................................................................119
— Key catalysts .......................................................................................119
— Risks ...................................................................................................119
— UBS vs. consensus..............................................................................120
— Valuation and basis for our price target................................................120
— Sensitivity ............................................................................................121
— Baidu.com Inc ..................................................................................................131
— Investment Thesis......................................................................................132
— Key catalysts .......................................................................................132
— Risks ...................................................................................................133
— UBS vs. consensus..............................................................................133
— Valuation and basis for our price target................................................133
— Sensitivity ............................................................................................134
— Alibaba.com.....................................................................................................145
— Investment Thesis......................................................................................146
— Key catalysts .......................................................................................146
— Risks ...................................................................................................147
— UBS vs. consensus..............................................................................147
— Valuation and basis for our price target................................................147
— Sensitivity ............................................................................................148