Battle of the Internet giants IV: TAM'ing the profit pool

62 Pages·2016·1.36 MB·English

May 17, 2016
China: Technology: Internet

Equity Research
Battle of the Internet giants IV: TAM’ing the profit pool
Turning positive on profits and focusing on the ‘Seven Pillars’
For the first time since 2010, we have a high degree of confidence in the BUY-RATED NAMES WITH KEY EXPOSURE TO SEVEN
PILLARS
long term growth and potential (operating) profit pool for China Internet.
Tencent* Baidu Alibaba JD.com
This is in contrast to 2010-15 when margins slipped on high competition, Games 
Online Ad.   
there was a need to acquire customers, and an impetus to tackle new E‐commerce  
entrants. As such, we believe now is the right time to examine the 2020E Travel  
Local Services    
industry profit pool verticals we call the ‘Seven Pillars’ – games, online Internet Finance    
advertising, e-commerce, travel, local services, internet finance, and cloud. Cloud Computing   
*Denotes stock is on our regional Conviction List
Four key takeaways Source: Company information, Goldman Sachs Global
Investment Research.
On TAM: Mobiles have exploded the overall total addressable market
(TAM), with our estimates (ex-fins) suggesting a ~US$10tr opportunity by SEVEN PILLARS OF CHINA INTERNET
2020. We believe the market has underappreciated the stickiness of PC 1. Games: China, living in a virtual world
gaming and the attraction of mobile games. The next main sector growth 2. Online advertising: Social, online video and search are
growth engines
drivers should come from financial services and local services going online.
3. E-commerce: 3x increase to US$1.5tn by 2020E
On profit pools: We believe there is immense online profit opportunity 4. Online Travel: A US$200bn opportunity by 2020E
(~US$70bn by 2020E) were these businesses to be run solely to maximize 5. Local services O2O: Building a second BABA, US$1.4tn
TAM (2020E)
profitability, as was the case with Ctrip in 2010, Baidu in 2011 and Alibaba
6. Internet Finance: Tapping the underbanked China
in 2013, when operating profit margins were at record levels. consumer; a US$5.4tn opportunity (2020E)
7. Cloud computing: A ~US$20bn opportunity (2020E)
On reinvestment: With the profit pool dampened by investment into new
RELATED RESEARCH
businesses, we have started moving towards SOTP valuations to reflect an
Tencent Holdings (0700.HK): Weixin: the north star (2);
increasing degree of confidence in synergistic growth. Leveraging current
multiple drivers intact; reiterate CL-Buy, April 13, 2016
assets and positioning for the next major opportunities (internet finance, China: Technology: Internet: Upcoming MSCI inclusions:
What to own; Tencent to CL-Buy, November 30, 2015
O2O) will be key.
NetEase Inc. (NTES) Buy: Games leader and new growth
On who is best positioned: Those with social network assets appear best seeker; initiate at Buy, November 25, 2015
positioned, due to the growth opportunity, the significant barriers to entry, China: Technology: Internet: Shopping sans frontières: Buy
China online retail – BABA/JD/VIPS, November 6, 2015
the substantial upside to ad-loads, and the time spent on the app.
China: Technology: Internet: Planes, Trains, and Hotel
Rooms; Buy Ctrip, Qunar, October 26, 2015
Alibaba, Baidu, and Tencent could be major beneficiaries
China: Financial Services: Internet Finance Part 1: Clash of
the Titans unfolds; Midcap banks face risk of
We are positive on Tencent (CL-Buy), Baidu (Buy), and Alibaba (Buy) given
marginalization, November 14, 2014
their exposure to the three major growth drivers for the online advertising
industry into 2020E – social advertising, online video, and search. Also,
Alibaba dominates e-commerce via its unique monetization proposition,

Tencent is the dominant gaming platform in China, and Baidu the default
search engine in China. All three have exposure to local services, while
Baidu is ramping up its internet finance arm. Of the remaining pillars,
Baidu has online travel exposure via Ctrip (Buy) investment, while Alibaba
and Tencent lead in cloud computing, one of the fastest growth areas.
Piyush Mubayi Goldman Sachs does and seeks to do business with
[phone] [email protected] Goldman Sachs (Asia) L.L.C.
companies covered in its research reports. As a result,
George Meng, CFA
[phone] [email protected] Goldman Sachs (Asia) L.L.C. investors should be aware that the firm may have a conflict of
David Jin, CFA interest that could affect the objectivity of this report. Investors
[phone] [email protected] Goldman Sachs (Asia) L.L.C. should consider this report as only a single factor in making
Fan Liu, CFA their investment decision. For Reg AC certification and other
[phone] [email protected] Beijing Gao Hua Securities Company Limited
important disclosures, see the Disclosure Appendix, or go to

www.gs.com/research/hedge.html. Analysts employed by non-
US affiliates are not registered/qualified as research analysts
with FINRA in the U.S.
The Goldman Sachs Group, Inc. Global Investment Research
May 17, 2016 China: Technology: Internet

Table of contents
China Internet Opportunity in Pictures 3
China Internet in Numbers 5
PM Summary: ‘Seven Pillars’ drive a ~US$70bn profit pool in 2020E 6
The Seven Pillars of China Internet 10
1. Games: China, living in a virtual world 11
2. Online advertising: Social, online video and search are growth engines 19
3. E-commerce: 3x increase to US$1.5tn by 2020E 30
4. Online travel: A US$200bn opportunity by 2020E 35
5. Local services O2O: Building a second BABA, US$1.4tn TAM (2020E) 38
6. Internet finance: Tapping the underbanked China consumer; a US$5.4tr opportunity (2020E) 42
7. Cloud computing: A ~US$20bn opportunity (2020E) 46
Appendix 1: China internet usage 51
Appendix 2: M&A summary 52
Appendix 3: Valuation and risks 56
Appendix 4: TAM table in details 57
Appendix 5: TAM detail in RMB 59
Disclosure Appendix 60

All prices in this report as of May 13, 2016, unless otherwise noted. The authors would like to thank Jason Huang, Elsie Cheng, Shaphan
Ng and Kenneth Bang for their valuable contributions to the report.

Exhibit 1: China Internet Comps
P/E, non-GAAP PE at TP
Last Target +/- Mkt Cap Performance diluted EV/Revenue PEG non-GAAP
Company Ticker fx Price Price Side Rating (US$mn) 3Mo YTD 2016E 2017E 2016E 2017E 2016E 2016E 2017E
China Internet
58.com WUBA $ 5 0.50 6 4.0 27% Neutral 5 ,803 14% -23% NM 27.8x 4.2x 2.9x NM NM 35.2x
Alibaba BABA $ 7 7.16 1 00.0 30% Buy 1 96,758 27% -5% 27.0x 21.6x 8.7x 6.8x 1.1x 35.0x 28.1x
Autohome ATHM $ 2 4.80 - - Not Rated 2 ,904 4% -29% 16.2x 12.6x 2.6x 2.2x 0.6x - -
Baidu BIDU $ 1 59.75 2 20.0 38% Buy 5 6,520 5% -15% 26.6x 17.8x 4.2x 3.5x 0.6x 36.7x 24.5x
Changyou CYOU $ 1 7.67 1 6.9 -4% Sell 9 34 9% -29% 9.2x 8.4x 0.7x 0.7x 1.1x 8.8x 8.0x
Ctrip CTRP $ 4 3.01 5 5.0 28% Buy 2 1,017 16% -7% 80.8x 30.0x 7.1x 5.3x 0.8x 103.3x 38.4x
JD.com JD $ 2 2.64 33.0 46% Buy 3 1,092 -2% -30% NM 50.5x 0.7x 0.5x NM NM 73.7x
Jumei JMEI $ 5 .29 9 .5 80% Neutral 7 99 -4% -42% 14.2x 8.8x 0.5x 0.4x 0.3x 25.4x 15.9x
NetEase NTES $ 1 53.40 1 82.0 19% Buy 2 0,281 11% -15% 14.0x 14.3x 3.2x 2.5x 1.9x 16.6x 17.0x
Qunar QUNR $ 3 5.75 4 5.0 26% Neutral 5 ,272 2% -32% NM 98.5x 6.3x 4.5x NM NM 124.0x
Sina SINA $ 4 5.50 4 8.0 5% Neutral 2 ,683 9% -8% 28.1x 21.3x 1.2x 1.0x NM 29.7x 22.5x
Sohu SOHU $ 3 9.52 4 1.0 4% Sell 1 ,529 -11% -31% NM 21.5x 0.4x 0.3x NM NM 22.3x
SouFun SFUN $ 5 .58 6 .8 22% Neutral 2 ,376 15% -24% NM 16.5x 1.3x 0.9x NM NM 20.1x
Tencent 0700.HK HK$ 1 55.10 1 93.0 24% Buy* 1 88,386 16% 2% 28.6x 22.5x 8.6x 7.0x 1.2x 35.6x 28.0x
Tuniu TOUR $ 8 .97 1 5.0 67% Neutral 1 ,190 -18% -44% NM NM 0.4x 0.3x NM NM NM
VIPShop VIPS $ 1 2.00 1 7.5 46% Buy 7 ,663 10% -21% 18.8x 14.7x 1.0x 0.8x 0.8x 27.4x 21.4x
Weibo WB $ 2 3.30 2 2.0 -6% Neutral 5 ,195 93% 19% 43.7x 24.4x 8.0x 5.6x 0.7x 41.3x 23.0x
Median (Sum for Mkt cap) 26% 5 50,401 9% -23% 26.6x 21.4x 2.6x 2.2x 0.8x 32.3x 23.0x

Notes: *Denotes stock is on our regional Conviction List. All target prices are on a 12 month basis.
Source: DataStream, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research 2
May 17, 2016 China: Technology: Internet

China Internet Opportunity in Pictures
Exhibit 2: Seven Pillars of China Internet

Notes: TAM = Total Addressable Market. The TAM numbers for e-commerce, travel, O2O, cloud, and internet finance relate to the whole industry size. CAGR is for
2015-2020E (in USD).Top 2 players is by market share. For RMB version please see Appendix 5.
Source: iResearch, eMarketer, NBS, CNNIC, Analysys, Wind, Sina news, Goldman Sachs Global Investment Research.
Exhibit 3: We expect China’s internet penetration to increase from 50% in 2015 to 60% by
2020 (to 847mn, 97.6% of which would be mobile internet users vs. 90% in 2015)
(mn)
1,000 Total Internet Users(mn) 70%
900 Mobile Internet Users(mn)
60%
Internet users penetration %(RHS)
800
700 50%
600
40%
500
30%
400
300 20%
200
10%
100
- 0%
2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E
Source: CNNIC, iResearch, Goldman Sachs Global Investment Research.

Goldman Sachs Global Investment Research 3
Exhibit 4: The China internet opportunity in a global context M
G
oldm ay 17
an , 2
Sach CPohpuilantiaon 016
s G 1,376mn
lo Internetpenetration 13%
ba 50% Japan
l In GDP Population 37% 50%
ve $10,847bn 127mn
stme e$C7o2m1mb+nTr a-vNel+oA.d1s size I9n1te%rnetpenetration 45%
nt R G$D4P,121bn
e
s eComm+Travel+Adssize
ea Europe $116bn -No.4
rc
h Population
822mn
Internetpenetration India Korea US
74%
G$1DP6,947bn P1o,2pu5la2timonn P4o9pmulantion P3o2p1ulmatinon 5%
e$C3o8m3mb+nTr a-vNel+oA.d3ssize I3n0te%rnetpenetration I9n2te%rnetpenetration I8n7te%rnetpenetration 34%
GDP GDP GDP
$2,060bn $1,357bn $17,943bn 26%
eComm+Travel+Adssize eComm+Travel+Adssize eComm+Travel+Adssize
$36bn -No.6 $48bn -No.5 $559bn -No.2
9%
70%
Internet Penetration
7% 10% 1% 10%
eCommerce
45% 47% 39% 66%
Travel
31% 32% 14% 28%
26% Advertising
13%
8%

Note: Data as of 2015.
Source: eMarketer, Phocuswright, InternetWorldStats, Goldman Sachs Global Investment Research.
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May 17, 2016 China: Technology: Internet

China Internet in Numbers
CHINA INTERNET USER CHINA INTERNET USER DEMOGRAPHICS
75% users between 10-39 years old
620mn mobile internet users = 2x US pop.
72% from urban cities
China has 620mn mobile internet users, 90% of the 688mn 54% of internet users
total internet users. Internet penetration has surpassed Age: 10‐39 are male, 67% are of
50%, and we expect it to grow to 60% with 847mn internet secondary/high school
75%
users in 2020E. educational level.
ONLINE ADVERTISING E-COMMERCE
ADS
Online ad spend as % of total ad spend: Online penetration to reach 22% in 2020E
China: 45% vs. US: 33% from 13% in 2015.
TAM: Rmb552bn in 2020E, 21% CAGR in 2015-20E. We Category penetration (2014):
forecast search ad spend is currently ~33% of the market Books & Magazines: 40% Phones: 19%
and social ad spend to grow fastest at 31% CAGR (2015- Apparel: 31% Digital: 17%
20E). Cosmetics: 22% Home appliance: 10%
GAMES TRAVEL
China surpassed the US as the world's 2014 OTA penetration in China: 28%
largest gaming market, Rmb144bn TAM in 2015 vs. 45% in the EU and 43% in the US.
Mobile gaming should exceed PC online gaming in 2016. 1. People booking trips online in China: 260mn  4th most
eSport player population to grow at 23% CAGR (2015- populated country: Indonesia.
2018E). 2. Trips booked on mobile platforms 34% as of online.

LOCAL SERVICES/O2O CLOUD COMPUTING
China cloud market to grow at 18% CAGR to
Online penetration to reach 12% in 2020E
Rmb127bn by 2020E
70% of movie tickets booked online in 2015, up from IaaS, PaaS and SaaS in China expected to grow at
45%/25% in 2014/2013. 51% of the bookings on mobile. 20%/23%/22% CAGR till 2020E. We expect AliCloud to
The top 3 (Maoyan, Weipiao, Gewara) ~55% market share. capture 28% market share in 2020E vs. 3% in 2015.
INTERNET FINANCE TENCENT (0700.HK) T
BA
$
AliPay: 400mn+ real-name registered users 55.2% Weixin users open the app >10
TenPay: 300mn users with bankcards linked times/day and time spent is 2x Facebook.
MAU (end-2015): 549mn
AliPay and TenPay combined is 67.5% of China's total third Average Weixin user age: 26
party online payment transaction volumes. 86.2% of users are between 18-36 years old
90%+ smartphones installed Weixin in China
ALIBABA (BABA) A BAIDU (BIDU) B
B T AT
No.1 search engine in China. 1,049k SME customers.
407mn active buyers, avg. spend Rmb7,249 per annum
Mobiles 60% of 1Q16 rev.
Achieved GMV RMB3tn milestone in FY2016. Single's Day 150%
Paid Clicks
2015 attracted 115mn buyers, transacted GMV Rmb91bn 100%
Cost per click
50%
through AliPay; Rural Taobao penetrated over 12,000 of Search rev.
0%
China's 600,000 villages. 200720082009201020112012201320142015
-50%

Notes: Data as of 2015, unless stated.
Sources: Company data, iResearch, eMarketer, CNNIC, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research 5
May 17, 2016 China: Technology: Internet

PM Summary: ‘Seven Pillars’ drive a ~US$70bn profit pool in 2020E
Exploring the ‘Seven Pillars’ that constitute the long term drivers of China Internet – games, digital
marketing, e-commerce, online travel, local services O2O, internet finance, and cloud computing – we
quantify the market potential to 2020E (revenue/profit pool) and look at the industry leaders in each pillar.
Focus shifting to long term pillars of growth after a year of M&A
Following a number of transformative China internet mergers in 2015 and a prudent private
equity market, the drag on margins from competition and disruptive companies on the
sector’s profit outlook has decreased, in particular for BAT (Baidu, Alibaba, and Tencent).1
In this report our focus is on how the 2020E industry profit pool by vertical looks, driven by
the long term pillars (‘Seven Pillars’) of China Internet – games, online advertising, e-
commerce, travel, local services O2O (online to offline), internet finance, and cloud. The
analysis enhances our confidence on China Internet’s long term growth and the potential
(operating) profit pool, with possible margin upside surprise. Key to capitalizing on this
opportunity will be individual company strategies pursued for the next phase of growth.
We have moved both the Alibaba and Baidu valuation methodology to SOTP to reflect the
growing degree of confidence in synergistic growth and to take a longer term view of the
valuation creation in the loss making businesses as they transform into profitable growth
drivers.2
Exhibit 5: Categorizing internet verticals by development stages
Survival of the fittest
Market concentration M&Ain public space, moving
Strong firms go public/ to market structure stability
Survival of the gain share -Online travel,
"Richest" --EP-2cPo lmenmdeinrcge, ,etc. --OOnnlliinnee gviadmeoin, ge,t c.
M&Ain private space
-Taxi hailing, etc.
Consumer is "King"
Heavy discounting
-O2O e.g. Online Food
Delivery.
Start-ups boom
Business model recognized, PE
capital flows in
-Online new car/ used car transaction
platforms,
-FinTech, etc.
To Be or Not To Be
Online adoption begins
Newbusiness ideas, e.g.
Developmentphase

Source: Goldman Sachs Global Investment Research.

1 For details of the five largest China Internet deals in 2015, Baidu’s investments over the past 11 years, Alibaba’s
M&A history since April 2013, and Tencent’s 100+ investments in the past five years, please see Appendix 2.
2 See ‘Alibaba: Above expectation: Switch to SOTP to capture strategic investments’, May 6, 2016 and ‘Baidu:
Building BABA for local services; maintain Buy’, July 30, 2015.
Goldman Sachs Global Investment Research 6
May 17, 2016 China: Technology: Internet

Seven Pillars by 2020E: Over US$2tr online market, ~US$70bn profit
Over the last two years we have discussed many of the individual growth pillars for China
Internet. For the first time we combine research on each of these pillars (the ‘Seven Pillars’),
to reach an estimated total addressable market (TAM) ex-financials for China Internet of
Rmb65tr (US$10tr) in 2020. We estimate the total size of the online market (ex-fins) could
reach Rmb13.4tr (US$2.0tr) by then, implying 21% online penetration (8pp higher than
2015’s 12%). We exclude financials from our market sizing analysis as the TAM is too big
for the internet companies to meaningfully penetrate. Our China banks team model
~Rmb1,200tr (~US$180tr) total bankcard transaction value + total social financing (TSF, excl.
bonds and equities) by 2020E, with online penetration only expected to be 3.2% and 1.5%
respectively by then (Exhibit 6).
Taking our analysis one step further, we expect the total online profit pool (ex-fins) for
China Internet to reach Rmb393bn (US$59bn) by 2020. While this figure likely captures the
industry’s growth potential, it may also exclude spending on projects for the next phase of
growth. Our combined operating profit for BAT by end-2020E is Rmb308bn (vs. Rmb97bn
in 2015), equivalent to 78% of the total, which puts the overall pool into context. As shown
in Exhibit 7, we expect the top 3 profit contributors to be online adspend (Rmb169bn, 43%
of total), online games (Rmb106bn, 27% of total) and e-commerce (Rmb79bn, 20% of total).
For detailed information on each of the Seven Pillars, please see our segment analysis
(page 12 onward).

Exhibit 6: China Internet: TAM analysis into the ‘Seven Pillars’
The online opportunity (ex-finance) is potentially >Rmb13tn
Total Addressable Market Latest update David Jin, on March 23, 2016
RMB bn 2014 2015 2016E 2017E 2018E 2019E 2020E Cagr 15-20 Companies with exposure
GDP 63,689 67,940 69,428 74,161 79,040 85,067 91,383 6.1%
TAM assessment, by category
1. RETAIL 26,239 30,093 33,403 36,744 40,051 43,455 46,931 9%
E-Commerce 2,790 3,877 5,079 6,400 7,744 8,983 10,151 21% Alibaba, JD, VIPS, Jumei, Netease
2. ADSPEND 396 467 553 629 699 770 842 13% Alibaba, Baidu, Tencent
Online Adspend 154 210 276 345 411 480 552 21%
3. TRAVEL (OTA TGT.) 1,308 1,444 1,590 1,744 1,908 2,089 2,270 9%
OTAs 366 527 634 758 901 1,056 1,231 18% Ctrip, Qunar, Alitrip, Tuniu
4. LOCAL SERVICES (O2O) 5,329 5,992 6,641 7,280 7,936 8,571 9,256 9%
Online 237 324 438 575 730 900 1,111 28% Meituan, Baidu Nuomi, Koubei
5. ONLINE GAMES 110 144 183 221 251 266 277 14% Tencent, Netease, Changyou
Mobile [phone] 172 25%
PC+browser 83 87 92 96 99 102 105 4%
6. IT SPENDING 3,049 3,593 4,107 4,577 4,995 5,361 5,675 10%
Cloud computing 44 56 72 90 100 114 127 18% Alibaba, Baidu, Tencent
Online, ex-finance 3,701 5,138 6,682 8,389 10,137 11,799 13,449 21%
7. FINANCE 6,990 9,713 13,385 18,118 23,611 29,295 36,047 30% Alibaba, Baidu, Tencent, JD
a.Total bankcard transaction 495,331 569,631 646,531 730,580 818,250 908,257 1,008,165 12%
% online penetration 1.4% 1.7% 2.0% 2.4% 2.7% 3.0% 3.2% 2pp Change in pp, '15-'20E
b.TSF excl. bond and equity 110,612 125,461 142,303 159,272 178,264 199,520 223,311 12%
% of total bank loans 0.0% 0.1% 0.1% 0.3% 0.7% 1.1% 1.5% 1pp Change in pp, '15-'20E
Total Addressable Mkt. (ex finance) 36,432 41,733 46,477 51,195 55,839 60,511 65,252 9%
% of GDP 57.2% 61.4% 66.9% 69.0% 70.6% 71.1% 71.4%
Online (ex finance) 3,701 5,138 6,682 8,389 10,137 11,799 13,449 21%
% of TAM online 10% 12% 14% 16% 18% 19% 21% 8pp Change in pp, '15-'20E
% of TAM online (ex ecomm) 9% 11% 12% 14% 15% 17% 18% 7pp Change in pp, '15-'20E
Source: Company data, iResearch, eMarketer, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research 7
May 17, 2016 China: Technology: Internet

Exhibit 7: China internet profit pool estimates
Online adspend, online games and e-commerce are the top 3 profit pool contributors by 2020E
2015 2020E
Profit pool (Rmb bn) OP/TAM OP Split OP/TAM OP Split Exposure/Comment
1. RETAIL
E-Commerce 0.3% 1 3 17% 0.8% 79 20% Alibaba, JD, VIPS, Jumei, Netease
2. ADSPEND
Online Adspend 43.1% 59 80% 46.2% 169 43% Baidu, Tencent, Alibaba
3. TRAVEL (OTA TGT.)
OTAs -0.4% ( 2) -3% 1.0% 12 3% 5% take rate, 20% margin, incl. outbound
4. LOCAL SERVICES (O2O)
Online -9.4% (30) -41% 0.6% 7 2% 6% take rate, 10% margin
5. ONLINE GAMES 32.2% 4 6 63% 38.4% 106 27% Tencent, Netease, Changyou
Mobile 1 1 15% 43 11%
PC+browser 3 5 47% 63 6%
6. Cloud computing -20.0% (11) -15% 15.0% 19 5% Alibaba, Baidu, Tencent
Total, ex finance 1.4% 7 4 86% 2.9% 393 83%
7. FINANCE 0.1% 1 2 14% 0.2% 80 17% Alibaba, Baidu, Tencent, JD
a.Online payment 0.1% 1 0 12% 0.1% 33 7% 0.18% take rate, 57% margin
b.SME lending 2.3% 2 2% 1.4% 47 10% 9% interest rate, 36% margin (incl. 2.5% credit cost)
TOTAL 8 6 473
2015 2020E
OPM (%) OP Split OPM (%) OP Split
Alibaba 607.5% 4 2 58% 748.4% 1 41 36%
Baidu 19.7% 1 3 18% 32.8% 5 5 14%
Tencent 40.6% 4 2 57% 42.1% 1 12 29%
BAT Total 55.2% 9 7 132% 68.0% 308 78%
Source: Company data, Goldman Sachs Global Investment Research.
Exhibit 8: Online advertising has the highest profit pool because of high margin on
established business models; internet finance has the highest growth potential due to the
lowest online penetration
Seven Pillars snapshot, by profit pool size, growth profile, and online penetration
120% Online penetration:
2020E
Cloud
Online
100% gaming computing
80%
Online
advertising
60%
Online
travel
40%
Local
E-commerce services
20%
0%
Online market size Internet
CAGR: '15-'20E finance
-20%
0% 5% 10% 15% 20% 25% 30% 35%

Note: *Bubble size represents 2020E operating profit pool for each Pillar (see Exhibit 7 for data).
Source: Company data, iResearch, eMarketer, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research 8
May 17, 2016 China: Technology: Internet

Who is best placed to benefit? Alibaba, Baidu, and Tencent
Online advertising: BAT, via search, social and e-commerce each has a unique ad
proposition. For search, Baidu (Buy) demonstrates consistent Paid Click and cost-per-click
trends and appears primed for better mobile monetization. With social ad spending in
China (Rmb85bn in 2020E) and social mobile monetization, we see Tencent (CL-Buy) as a
key beneficiary given its powerful social network asset, Weixin. Merchants place ads on the
Alibaba (Buy) platform for traffic acquisition, brand building and customer engagement.
What is common across BAT is their exposure to online video, the fastest growing vertical
and a major driver of traffic in China.
Games: We believe the market may underestimate the overall potential of player vs player
games, across PC and mobiles in China, and see growth into 2020E driven by shifting
genre and rising ARPU. Tencent remains the market leader in games for its strong
distribution capability, IP inventory and control of Weixin. We expect NetEase (Buy) to
leverage its strength in game development, while rising uncertainty on game launch plans
and increasing competition is likely to negatively impact Changyou (Sell).
E-commerce: Alibaba dominates China retail, via a unique monetization proposition that
has built up its enormous user base (423mn), and we expect the structural movement from
offline to online to continue driving growth in the industry. We believe JD.com (Buy) will
remain the second largest e-commerce player given its strong in-house logistics network.
Cloud computing: Although we believe cloud computing in China lags the US by four years,
we are confident spending on cloud will be one of the fastest growth areas within China
internet. Alibaba and Tencent are currently the two largest cloud service providers in China.
Online travel: We remain positive on the outlook for China’s online travel market, with
resilient travel spending growth and the secular story of rising online penetration. We see
Ctrip (Buy) as a key beneficiary given its leadership across business lines and solid margin
enhancement along with the ongoing integration with Qunar.
Local services: Online local services in China are likely to be better exploited by the internet
giants, in contrast to other parts of the world. BAT looks well positioned to capitalize on the
changing of user habits, enabling them to: 1) capture the trend of spending online across
multiple partners, 2) benefit from traffic to payment gateways, and 3) expand the
advertising customer base given the number of small merchants coming online.
Internet finance: We believe the role of payment solutions offered by internet companies
has been underappreciated by the market due to the low take rates (i.e. the commission
rate). However, customers are likely to largely come from the existing user bases of BAT,
thus these three could make headway in the underbanked China consumer by adding more
financials services online.
Exhibit 9: Market share in each of the Seven Pillars (2015)
Ecommerce Online Adspend OTA O2O
Alibaba, 9%
VIPS, 2% Other,
11%
Baidu,
JD, 12% Other, 30% Alibaba, 27% Ctrip, 26% Other, 23% 11%
Alibaba, 76% Sina, 2% Baidu, 28% Other, 73% Tuniu, 1% DiaMnpeiintuga, n5 7%
Sohu, 3%
Netease, 1%
Tencent, 9%
Online games Cloud Alibaba, 3% Internet Finance
Tencent, 2%
Other, 40% Tencent, 45% Others, 33% Alipay, 48%
Other, 95%
Tencent, 20%
Netease,
13%
Changyou, 3%
Source: iResearch, Analysys, Company data.
Goldman Sachs Global Investment Research 9
May 17, 2016 China: Technology: Internet

The Seven Pillars of China Internet
The Seven Pillars of China Internet

In this section, we present our seven key pillars for investing in China Internet
1. Games: China, living in a virtual world
2. Online advertising: Social, online video and search are growth engines
3. E-commerce: 3x increase to US$1.5tn by 2020E
4. Online travel: A US$200bn opportunity by 2020E
5. Local services O2O: Building a second BABA, US$1.4tn TAM (2020E)
6. Internet finance: Tapping the underbanked China consumer; a US$5.4tr opportunity
(2020E)
7. Cloud computing: A ~US$20bn opportunity (2020E)
Exhibit 10: Seven long-term pillars of the China Internet opportunity

Notes: TAM = Total Addressable Market. The TAM numbers for e-commerce, travel, O2O, cloud, and internet finance relate to the whole industry size. CAGR is for
2015-2020E (in USD). Top 2 players is by market share. For RMB version please see Appendix 5.
Source: iResearch, eMarketer, NBS, CNNIC, Analysys, Wind, Sina news, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research 10