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Giant Steps for China's Net

By Scott Kessler, Standard & Poor's I visited China some 10 years ago, in the summer of 1995 (about a month after Netscape's IPO). The country was literally being built around me. The highway between Beijing and its airport was just completed. The Orient Pearl TV Tower was the only major edifice in the now burgeoning Pudong business district of Shanghai. There were relatively few indications of U.S. influence, except for fast-food restaurants and a couple of billboards.

What a difference a decade makes.

The Internet has become arguably the world's most important medium for information gathering, communications, and commerce. And China is now an economic superpower. It's no surprise to us at Standard & Poor's that at some point these two developments would come together in an extremely palatable way, and earlier this month, I think this happened, largely due to U.S. interests.

"GOOGLE OF CHINA." On Aug. 5, Chinese search company (BIDU

: $92) went public in the U.S. After generating only $13.4 million in net revenues and $1.5 million in net income in 2004, the outfit was valued at as much as $4.9 billion on its first day of trading. The stock soared from $27 to an intraday high of $151.21. The shares have since fallen, but the interest in what has been dubbed "the Google of China" has been astounding, in our view.

Less than a week later, on Aug. 10, Yahoo! (YHOO

: 4 STARS, Buy; $34) announced a major transaction in China that it valued at some $4 billion. Pending necessary approvals, Yahoo would take a 40% stake in, a leader in Chinese e-commerce, in exchange for Yahoo's China assets and $1 billion.

The planned deal would combine Alibaba's domestic and international business-to-business online marketplaces, online auction company Taobao, and Internet payment service AliPay, with Yahoo's namesake Chinese portal, search properties, and majority stake in auction joint-venture 1pai.

AMERICAN INTERESTS. Chinese Internet companies such as (NTES

: $76), (SOHU

: $20), and SINA (SINA

: $29) have traded in the U.S. for years. Over the last couple of years, several major U.S. Internet companies have purchased or taken stakes in online outfits based in China: (AMZN

: 3 STARS, Hold; $44) bought online retailer in September, 2004.

CNET Networks (CNET

: 2 STARS, Sell; $13) acquired two Chinese Web sites in October, 2004. ZOL is focused on technology-related content and shopping services, and Fengniao is a digital-photography property. In April, 2005, CNET bought 90% of China's PCHome, which operates a personal-technology Web site.

eBay (EBAY

: 3 STARS, Hold; $40) acquired Internet auction company EachNet in July, 2003, after having acquired a minority stake in the company in March, 2002.

Google (GOOG

: 3 STARS, Hold; $286) took a stake in Baidu in June, 2004.

IAC/InterActiveCorp (IACID

: 3 STARS, Hold; $26) acquired a majority stake in Internet travel services company eLong (LONG

: $12) in January, 2005.

However, these were all relatively small transactions, the largest of which was eBay's purchase of EachNet for $175 million ($30 million for the initial minority stake, and $145 million to purchase the remainder).

NOTABLE APPEAL. In February, 2005, China's Shanda Interactive (SNDA

: 5 STARS, Strong Buy; $36) got into the act, by announcing that it and an affiliate had taken a 19.5% stake in SINA for $230 million.

We believe the multibillion dollar valuations ascribed to Baidu and the proposed Yahoo/Alibaba transaction indicate the market for Chinese Internet companies may have reached an inflection point.

With China's burgeoning economy, more than 100 million Internet users (making it the world's second-largest online population, behind the U.S.), and distinctive and challenging cultural, political, and regulatory circumstances, we believe that Chinese Internet outfits will continue to offer notable appeal.

MEASURING STICK. Corporate and individual investors seem to believe the opportunities offered by these companies more than offset the related risks. Until this notion is proven incorrect, we expect additional capital to pour into the segment. Perhaps some of the $4 billion Google hopes to raise with a proposed stock offering announced on Aug. 18 will find its way to China.

In February, 2005, eBay CEO Meg Whitman stood in front of a group of analysts and proclaimed that within a couple of years, success in China would be the measuring stick by which Internet companies around the world would be assessed. Her company plans to spend some $100 million there in 2005 alone, which, in our opinion at S&P, seemed like a pretty large amount when it was announced.

However, based on some of the recent activity described above, $100 million this year might not be enough. As I witnessed 10 years ago, things can happen pretty fast in China, and if eBay isn't sufficiently aggressive, it could end up failing to live up to the benchmark it pronounced earlier this year.


S&P STARS - Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (Stock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index)), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank (also known as S&P Quality Rank)- Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:

A+ Highest B- Lower

A High C Lowest

A- Above Average D In Reorganization

B+ Average NR Not Ranked

B Below Average

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S&P Core Earnings - Standard & Poor's Core Earnings is a uniform methodology for adjusting operating earnings by focusing on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

Standard & Poor's Equity Research Services Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo, Standard & Poor's Malaysia Sdn Bhd and Standard & Poor's Information Services (Australia) Pty Ltd.

Required Disclosures

In the U.S.

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations and 12.3% with sell recommendations.

In Europe

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.4% of issuers with buy recommendations, 46.8% with hold recommendations and 18.8% with sell recommendations.

In Asia

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 33.3% of issuers with buy recommendations, 47.2% with hold recommendations and 19.5% with sell recommendations.


As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.4% with hold recommendations and 13.6% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index, in Asia the S&P Asia 50 Index, and in Malaysia the KLCI or KL Emas Index.

For All Regions:

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request.

Other Disclosures

This report has been prepared and issued by Standard & Poor's and/or one of its affiliates. In the United States, research reports are prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). In the United States, research reports are issued by Standard & Poor's ("S&P"), in the United Kingdom by Standard & Poor's LLC ("S&P LLC"), which is authorized and regulated by the Financial Services Authority; in Hong Kong by Standard & Poor's LLC which is regulated by the Hong Kong Securities Futures Commission, in Singapore by Standard & Poor's LLC, which is regulated by the Monetary Authority of Singapore; in Japan by Standard & Poor's LLC, which is regulated by the Kanto Financial Bureau; in Sweden by Standard & Poor's AB ("S&P AB"), in Malaysia by Standard & Poor's Malaysia Sdn Bhd ("S&PM") which is regulated by the Securities Commission and in Australia by Standard & Poor's Information Services (Australia) Pty Ltd ("SPIS") which is regulated by the Australian Securities & Investments Commission.

The research and analytical services performed by SPIAS, S&P LLC, S&P AB, S&PM and SPIS are each conducted separately from any other analytical activity of Standard & Poor's.

S&P and/or one of its affiliates has performed services for and received compensation from YHOO, AMZN, CNET, EBAY, and IACID during the past 12 months.

SOHU, GOOG and SNDA are not customers of S&P or its affiliates.


This material is based upon information that we consider to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investor's currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

For residents of the U.K. this report is only directed at and should only be relied on by persons outside of the United Kingdom or persons who are inside the United Kingdom and who have professional experience in matters relating to investments or who are high net worth persons, as defined in Article 19(5) or Article 49(2) (a) to (d) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001, respectively. Kessler covers Internet Software & Services and Internet Retail stocks for Standard & Poor's

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