21 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Google Is Most Used by Young, High Income Participants Although Google dominates all demographic levels, our survey found it had its largest market share among those aged 18-41, and those with incomes over $100K. The majority of Yahoo!, MSN and AOL users in our study fell into the over-42 age group. MSN and AOL had their largest market shares among users with income levels of $50K-$99K, while the market share for Yahoo! was highest among those who earned $49K or less. Table 7: Market Share by Age and Income Level % of participants Ages Incomes: All 18-41 42+ $0-$49K $50-$99K $100K+ AOL 6.6% 4.8% 8.0% 5.9% 7.3% 6.9% Ask 2.0% 2.5% 1.7% 2.5% 2.2% 0.0% Google 59.0% 67.1% 52.2% 55.9% 60.4% 70.1% MSN 7.7% 5.1% 9.5% 7.4% 7.7% 6.9% Yahoo 20.0% 18.0% 22.7% 24.1% 17.6% 12.6% Other 3.1% 2.2% 3.7% 3.2% 2.9% 2.3% Don't Use/Don't Know 1.5% 0.3% 2.2% 1.0% 1.8% 1.1% Source: J.P. Morgan research 62% of Respondents Would Be Willing to Consider Switching Search Engines When asked what improvements by other search engines would cause them to switch from their preferred brand, only 38% of respondents stated that nothing would cause them to switch, as they were satisfied with their current search engine. This was consistent with last year’s survey responses. Again, the most frequently selected improvement was results that better matched the search term, with 45% of respondents stating that this would cause them to switch search engines. Other factors that would cause respondents to consider switching search engines were faster response speeds to searches (28%), the user friendliness of the site (27%), and the ability to preview web content (23%). Table 8: Factors that Would Cause Search Engine Switching % of participants All AOL Ask Google MSN Yahoo Other Results that better match my search term 45.0% 42.0% 25.0% 48.6% 33.3% 43.3% 34.8% Results that include video, web, music and oother forms of information 11.5% 12.0% 18.8% 11.5% 14.0% 9.6% 13.0% A more uncluttered easy to navigate site 26.5% 20.0% 31.3% 24.9% 36.8% 29.9% 17.4% The ability to preview web content 22.6% 24.0% 25.0% 21.9% 22.8% 26.1% 8.7% Faster response speed to searches 27.8% 36.0% 18.8% 25.8% 35.1% 29.3% 26.1% Other 0.7% 0.0% 0.0% 0.7% 3.5% 0.0% 0.0% Nothing, happy with current search engine 38.2% 30.0% 31.3% 37.5% 38.6% 41.4% 52.2% Source: J.P. Morgan research The Int’l Search Market Is Now Larger than the US Market We continue to believe the opportunities for paid search in the international marketplace are even more significant than in the US. By our estimate, while the UK is at par or ahead of the US market, the overall international paid search market is still 3+ years behind the US in terms of development. 22 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com The international market is now larger than the domestic market, reaching $15.0B in F’08. As such, we believe the international markets will be a key growth driver in the upcoming year. We think the largest driver will be query growth. While we expect the US to experience query growth of 19% Y/Y, we believe international markets will see a 25% Y/Y lift in the number of queries. However, offsetting these gains are likely declines in foreign currency exchange rates. As such, we see international RPS declines of 8% Y/Y in USD, which should mostly offset the higher query growth. We are now modeling F’09 paid search revenue growth of 15% Y/Y to $17.2B. Beyond 2008, we expect the international paid search market to grow at a 20% CAGR through 2011. Table 9: J.P. Morgan’s International Search Advertising Revenue Forecast Units as indicated International 2006 2007 2008E 2009E 2010E 2011E 08-'11E CAGR Internet Population (M) 817 903 988 1,072 1,153 1,239 7.8% Queries / Month / User 33 41 49 57 63 69 12.2% Number of Queries (M) 326,900 441,315 582,536 728,170 873,804 1,031,089 21.0% RPS (per 1,000 searches) $19.07 $23.19 $25.74 $23.63 $24.39 $24.93 -1.1% % Coverage 37.2% 38.3% 38.5% 38.5% 38.5% 38.6% 0.1% % Clickthrough Rate 17.2% 18.4% 19.1% 19.8% 19.8% 20.5% 2.4% $ Revenue / Click 0.30 0.33 0.35 0.31 0.32 0.32 -3.5% Int'l Search Forecast ($M) 6,233 10,235 14,993 17,208 21,315 25,701 19.7% Y/Y Growth 90.1% 64.2% 46.5% 14.8% 23.9% 20.6% Source: J.P. Morgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS We Think Google Will Continue to Take Market Share We estimate that Google has a 74% dollar market share currently (including revenues from AOL, Ask, and other affiliates). We believe its share will continue to grow at an accelerated pace in 2009 now that 1) the AOL and Ask TAC rates are locked in under a new multiyear contract, 2) Yahoo! is comping its monetization gains from Project Panama, and 3) we think advertisers are more likely to cut their spend with the other search engines and stick with the leader in a recession. On a query volume basis, we also expect Google to continue to excel in market share gains. 2008 saw Microsoft attempt everything from creating contests to increase search volume to actually paying users to purchase items through Microsoft search ads. Despite this, Google’s US core search market share increased to 62.9% in September 2008 from 58.4% in December 2007. 23 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Figure 8: US Core Search Market Share, September 2008 62.9% 20.2% 8.5% 4.1% 4.3% Google Sites Yahoo! Sites Microsoft Sites AOL LLC Ask Network Source: comScore and J.P. Morgan estimates Figure 9: US Core Search Market Share, December 2007 58.4% 22.9% 9.8% 4.6% 4.3% Google Sites Yahoo! Sites Microsoft Sites AOL LLC Ask Netw ork Source: comScore and J.P. Morgan estimates Search Advertising Likely to Be Winner in Macroeconomic Aftermath Although we acknowledge that all types of advertising, including search, will likely be hit by advertising budget reductions in 2009, we think search advertising will be the long-term winner in the reshuffling of budget allocations. We believe the weak macroeconomic environment has forced advertisers to test performance-based search advertising at an accelerated pace. Even after economic strength returns, we think advertisers will stick with their new allocations based on better metrics and higher measurable returns. Specifically, we see newspaper and radio advertisements suffering the most from these budget shifts. 24 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Table 10: Percent Change in Measured US Ad Spending, 1H’08 MEDIA SECTOR % CHANGE TELEVISION MEDIA -0.40% · Network TV -2.40% · Cable TV 3.10% · Spot TV -4.40% · Syndication - National 10.20% · Spanish Language TV -0.10% MAGAZINE MEDIA -1.80% · Consumer Magazines -1.80% · B-to-B Magazines -5.90% · Local Magazines -2.80% · Sunday Magazines 4.80% · Spanish Language Magazines 7.10% NEWSPAPER MEDIA -7.40% · Local Newspapers -7.10% · National Newspapers -9.50% · Spanish Language Newspapers -11.00% INTERNET (Display Advertising Only) 13.00% RADIO MEDIA -6.50% · Network Radio 3.40% · National Spot Radio -7.40% · Local Radio -7.50% OUTDOOR 1.80% FSIs 2.00% TOTAL -1.60% Source: TNS Media Intelligence and J.P. Morgan estimates 25 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com 2009 Graphical Advertising Outlook 2008 was a difficult year, as display advertising pricing (CPMs) was pressured not only from a non-premium inventory glut but also from lower ad budgets spent on premium slots. Unfortunately, we see these trends continuing into 2009. Specifically, we think 2009 growth will be impacted by: • Lower ad budgets given macroeconomic weakness and shifts towards performance-based advertising; • Continued pressure on non-premium inventory pricing as social networks and other non-traditional sites struggle to find a monetization model that works; • Difficult comps due to the 2008 Olympics and political campaigns; and • Continued trouble finding an appropriate way to monetize video inventory without alienating viewers. Having said this, we see pockets of strength for publishers who provide better targeting capabilities and who effectively use ad networks and ad exchanges to better monetize non-premium inventory. We Expect the Global Graphical Advertising Market to Grow 6.7% in F’09 We now think 2009 will be a weak year for graphical advertising publishers, as we expect the graphical ad sector to under-perform performance-based advertising in a down economy. On the back of estimated 14% Y/Y growth in 2008, we believe global graphical advertising revenues will grow 7% in F’09. From a metrics standpoint, we believe page views will grow 10% Y/Y while RPMs decline ~3% Y/Y. We expect the global Internet population growth to remain strong at 7% Y/Y, reaching 1.3B in 2009. We expect the global graphical advertising market to grow at an 11% CAGR through 2011. Table 11: J.P. Morgan's Global Graphical Advertising Revenue Forecast Units as indicated Global 2002 2003 2004 2005 2006 2007 2008E 2009E 2010E 2011E 08-'11E CAGR Internet Population (M) 593 710 820 924 1,020 1,113 1,205 1,295 1,380 1,471 6.9% Pages Viewed / User / Day 33 34 36 37 38 39 40 41 43 44 2.7% Total Pages Viewed (B) 7,209 8,897 10,724 12,607 14,275 15,986 17,793 19,590 21,510 23,539 9.8% RPM (per 1,000 pages) $1.02 $0.75 $0.81 $0.87 $0.97 $1.07 $1.09 $1.06 $1.09 $1.13 1.2% Global Graphical Forecast ($M) 7,354 6,674 8,642 10,984 13,829 17,068 19,368 20,670 23,494 26,536 11.1% Y/Y Growth -19.6% -9.2% 29.5% 27.1% 25.9% 23.4% 13.5% 6.7% 13.7% 12.9% Source: J.P. Morgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, and IAB US Growth Likely to Mirror the Global Market at 6.3% in F'09 We expect the US graphical advertising market to grow 6.3% in 2009, well below our year-ago estimate of 16.6%. We think that during 1H’09, US graphical advertising revenue will be flat to down slightly Y/Y. However, as the economy stabilizes, we expect 2H’09 display advertising to improve, resulting in our F’09 estimate of 6.3% Y/Y growth. We believe page view growth will slow to 6.5% in 26 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com 2009 (down from 7.2% in 2008) as social networking sites and blogs begin to mature and reach saturated penetration levels. By our estimates, page view growth will be driven by an increase of 2.5% in Internet users and an increase of 3.9% in usage per Internet user. We are modeling RPMs to be roughly flat in 2009, driven by a 2% decline in sell-through, offset by a 2% increase in CPMs. We expect the US graphical advertising market to grow at a 9.4% CAGR from 2008 through 2011. Table 12: J.P. Morgan's US Graphical Advertising Revenue Forecast Units as indicated United States 2006 2007 2008E 2009E 2010E 2011E 08-'11E CAGR Internet Population (M) 203 211 217 222 227 231 2.2% Pages Viewed / User / Day 45 47 49 51 52 54 3.4% Total Pages Viewed (B) 3,341 3,608 3,868 4,120 4,338 4,563 5.7% Impressions / Page 0.50 0.60 0.62 0.61 0.62 0.63 0.5% Total Impressions (B) 1,671 2,165 2,398 2,492 2,689 2,875 6.2% CPM (per 1,000 impressions) $3.50 $3.31 $3.32 $3.39 $3.50 $3.62 3.0% RPM (per 1,000 pages) $1.75 $1.99 $2.06 $2.05 $2.17 $2.28 3.5% US Graphical Forecast ($M) 5,847 7,166 7,950 8,449 9,413 10,407 9.4% Y/Y Growth 23.0% 22.6% 10.9% 6.3% 11.4% 10.6% Source: J.P. Morgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, and IAB International Growth Less of a Driver in 2009 International markets will likely suffer not only from lower ad spend due to the macroeconomy but also from lower foreign currency exchange rates. We think this will offset increased broadband penetration and increased ad spend moving online. We think page view growth will hold up and reach 11.1% Y/Y in 2009, down only slightly from 12.5% in 2008. However, we are modeling RPM declines of 3.7% Y/Y. We expect the international graphical advertising market to grow at a 12.2% CAGR from 2008 through 2011. Table 13: J.P. Morgan’s International Graphical Advertising Revenue Forecast Units as indicated International 2006E 2007E 2008E 2009E 2010E 2011E 08-'11E CAGR Internet Population (M) 817 903 988 1,072 1,153 1,239 7.8% Pages Viewed / User / Day 37 38 39 40 41 42 2.8% Total Pages Viewed (B) 10,934 12,378 13,925 15,470 17,172 18,975 10.9% RPM (per 1,000 pages) $0.73 $0.80 $0.82 $0.79 $0.82 $0.85 1.2% Int'l Graphical Forecast ($M) 7,982 9,902 11,418 12,222 14,081 16,129 12.2% Y/Y Growth 28.1% 24.1% 15.3% 7.0% 15.2% 14.5% Source: J.P. Morgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, and IAB Ad Prices Are Trending Down We have seen ad prices fall across almost all categories, at all sizes of publishers, and across all verticals. We think social networks are still the weakest in terms of CPMs, with PubMatic estimating the average CPM at $0.21 at the end of 3Q’08. As we have watched MySpace and Facebook struggle to find a better means of monetization, we think this will be a long process before an efficient marketing plan is established. Thus, we expect the social network vertical to continue to underperform. 27 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Figure 10: Website Ad Price Averages by Vertical units in dollars 0.00 0.20 0.40 0.60 0.80 1.00 1.20 Entertainment Business & Finance Gaming Sites News Social Networking Sports Technology 1Q08 2Q08 3Q08 Source: PubMatic AdPrice Index Quarterly Report Q3 2008 We also think it will take time for generalized non-targeted inventory to catch up to the monetization of targeted premium inventory. PubMatic estimates that the value of ad inventory for small-sized websites (less than 1M page views per month) was more than triple the value of large-sized websites (over 100M page views per month) in 3Q’08, with values of 61 cents and 18 cents, respectively. Figure 11: Website Ad Price Averages by Publisher Size units in dollars $0.00 $0.10 $0.20 $0.30 $0.40 $0.50 $0.60 $0.70 Small Medium Large Source: PubMatic AdPrice Index Quarterly Report Q3 2008 Aggregators of Traffic May Outperform While portals were once dominant, Yahoo!, AOL, and Microsoft only accounted for ~27% of minutes spent online in August 2008, down from 42% in August 2002. Meanwhile online gaming and social networking websites have experienced double- digit Y/Y growth rates in minutes spent online. This fragmented audience not only makes it more difficult for advertisers to reach their target audience through only a few publishers, but it also makes it difficult for publishers to attract advertisers given their limited scale. We believe companies that can aggregate traffic through the development of ad networks or partnerships will be more successful in driving 28 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com growth in 2009. Additionally, we believe demand for performance-based display advertising will grow in this difficult environment. While increasing user reach is half the battle, we recognize that many page views are meaningless to advertisers unless user information can be gathered and ads are targeted. In order to most effectively target the ads, publishers need to have access to user behavior on multiple sites to collect data and to repeatedly show ads to the same user. We believe companies with targeting capabilities will be able to command a premium CPM. Revenue Science estimates that there is a 15x CPM premium for behaviorally targeted ads. Figure 12: Behavioral Targeting Effects on CPM 0 200 400 600 800 1000 1200 1400 1600 123456789 Web impressions Percent Average CPM Dollars 80 70 12 10 8 6 4 2 0 20 40 60 80 Tier 3 < $1 Tier 2 $1-10 Tier 1 $10+ Revenue Science Targeting ~$10.00 - 12.00 Exchange model potential benefits ~$0.75 - 1.50 Traditional optimized ad network $0.50 - 1.00 Source: Revenue Science Presentation Figure 13: Internet Now Ranks Second in Time Consumption but Trails Significantly in Ad Spend 37% 7% 19% 8% 9% 29% 0% 5% 10% 15% 20% 25% 30% 35% 40% TV Internet Magazine Radio New spaper Yout h Adults & Teens Time Spent Vs Ad Spend Time Spent Vs Ad Spend Time Spent Time Spent 37% 38% 7% 19% 8%8% 6% 9% 20% 32% 0% 5% 10% 15% 20% 25% 30% 35% 40% TV Internet Magazine Radio New spaper Time Spent Ad Spend Largest DownsideLargest Upside Source: After TV: Nielsen Media Research Custom Survey 2008 and Samir Arora Glam Media Presentation 29 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Ad Networks on the Rise What Are Ad Networks? We see an ad network defined by the following: ¾ transacts, serves, tracks and reports the distribution of advertiser ads to publisher pages; ¾ enables marketers to advertise on multiple publisher sites through one central location; ¾ publishers enjoy the benefit of advertising revenue without investing in a sales force or as a source to sell remnant inventory; ¾ varies in the ability to target a specific audience and in methods of payment (CPM, CPC, and CPA); and ¾ revenues are determined by revenue share agreements. The definition of ad networks is fuzzy, with lead generation sometimes included. However, we are differentiating between the ad network and lead generation space. We are defining lead generation as much more targeted and deep into specific verticals. As a result, we believe this commands much higher CPMs. While we believe this is also an interesting ad model, we believe it deserves a more detailed consideration and will thus exclude it from this discussion. A Significant Market Opportunity We estimate that the global graphical advertising market as a whole will grow at an 11% CAGR through 2011. The sector should benefit from 1) increased online viewership as more people turn to the Internet as a source of content and 2) increased RPMs as audience targeting improves. Additionally, increasing keyword prices and the ability of networks to provide response advertising in addition to branding campaigns will likely drive more marketers to ad networks. On the publisher side, as the long tail of information is increasing, more publishers are looking to monetize their content. We estimate that the top 20 ad networks will earn approximately $7B+ in revenue in 2008 (~24% of the display ad market) and are growing much faster than the general graphical advertising industry. Lead generation is more vertical specific and performance oriented than ad networks. 30 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Table 14: Ad Networks by Page Views millions August Page Views (M) August Y/Y Growth Yahoo! Network 210,372 NA Google Ad Network 201,429 -17.5% Platform-A 137,660 NA ValueClick Networks 31,504 38.6% AdBrite 18,141 -36.4% Traffic Marketplace 18,513 -27.8% CPX Interactive 18,730 91.8% 24/7 Real Media 13,445 -0.7% Tribal Fusion 15,170 40.1% Kontera 15,248 704.7% Casale Media - MediaNet 10,720 12.0% DRIVEpm 8,951 199.1% Specific Media 9,514 76.0% Revenue Science 6,408 NA Pulse 360 5,390 NA interCLICK 6,165 209.5% ADSDAQ by ContextWeb 5,252 3.7% Collective Media 4,439 NA Burst Media 5,143 37.3% Vibrant Media 4,412 -13.4% Source: ComScore and J.P.Morgan estimates The Future of Ad Networks The ad network space is becoming increasingly competitive as new ventures are launched and as Google, Yahoo!, AOL, and Microsoft enter the space through acquisitions. We believe differentiation will be key to success. Following are capabilities that we see important to market leadership. Behavioral Targeting We believe advertisers used to pay for audiences on websites but will now start to pay for specific users. Marketers appear to value targeted advertising, as evidenced by Google’s well targeted search ads generating RPQs of more than double Yahoo!'s. We expect this same principal will apply to graphical advertising and note that Revenue Science estimates a 15x CPM premium for behaviorally targeted ads. Figure 14: Behavioral Targeting Effects on CPM 0 200 400 600 800 1000 1200 1400 1600 123456789 Web impressions Percent Average CPM Dollars 80 70 12 10 8 6 4 2 0 20 40 60 80 Tier 3 < $1 Tier 2 $1-10 Tier 1 $10+ Revenue Science Targeting ~$10.00 - 12.00 Exchange model potential benefits ~$0.75 - 1.50 Traditional optimized ad network $0.50 - 1.00 Source: Revenue Science Presentation Behavioral targeting should increase CPMs and drive volume. . (M) 32 6,900 441 ,31 5 582, 536 728,170 8 73, 804 1, 031 ,089 21.0% RPS (per 1,000 searches) $19.07 $ 23. 19 $25.74 $ 23. 63 $24 .39 $24. 93 -1.1% % Coverage 37 .2% 38 .3% . 38 .3% 38 .5% 38 .5% 38 .5% 38 .6% 0.1% % Clickthrough Rate 17.2% 18.4% 19.1% 19.8% 19.8% 20.5% 2.4% $ Revenue / Click 0 .30 0 .33 0 .35 0 .31 0 .32 0 .32 -3. 5% Int'l