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CommentPleaseseeanalystcertificationandotherimportantdisclosuresstartingonpage113.Page1IndustryEquityResearchGlobalMorganStanleydoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.IndustryOverviewSeptember12,2005RichardJi(Internet/Media-China)[phone]–[e-mail](Internet-US/Global)[phone]–NewYork/[e-mail]inDigitalChinaContributors:AndyXie(Economics-China)[e-mail](Telecom-China)[e-mail](Telecom-China)[e-mail](Telecom-China)[e-mail](Technology-China)[e-mail](US-Internet)[e-mail](US-Internet)[e-mail](China-Internet/Media)[e-mail]’stechnologyequityresearchreportsareavailableontheInternetthroughClientLinkat(alongwithothertechnologyoverviewreportsandpresentations)canalsobedownloadedfrom•WeareinitiatingcoverageoftheChinaInternetindustrywithanattractiveview.WebelieveChineseInternetcompaniesthatfocusoncreatingconsumervaluehavethehighestpotentialtocreateshareholdervalue.ChinaisNo.1intheworldinmobilesubscribersandNo.1inInternetusersundertheageof30-thisevolvingpresenceontheworldstageshouldnotbeunderestimated.•Weendeavortofindbusinesseswithrobustgrowthpotential,highbarrierstoentry,scalability,networkeffectsandlowregulatoryinterference.Weprefermanagementteamswhoareconsumer-centricandinnovative,andstockswhosesharepriceshaveoverlookedupsideplus‘marginsofsafety.’•Webelievethe‘clickplusbrick’modelmaydominateecommerceinChina;contentmayprovetobeking;foreigncompanieslagginginlocalizationmaylaginmarketpenetration;andlocalcompaniesmayneedtobecomesavvyacquirerstooutgrowrivals.•Onlinegamingisourfavoritesegmentpick.Localplayerswithself-developmentanddistributioncapacitymayemergeaslong-termwinners.•Webelievecompetitionisbreakingoutinonlinebrandadvertising,whichfacesinventoryoversupplyandasecularshifttowardperformance-centricmodels.Paidsearch,ontheotherhand,ispoisedforrobustexpansion.•Weviewmobilevalue-addedservicesasanoverlookedopportunity.Despiteregulatoryconcerns,entrybarriersarerisingandasegmentrecoveryisinsight.•Weseerisingopportunitiesinonlinecommerceincludingtravel,instantmessaging-relatedservicesandauctions.Emergingpaymentmechanismswillbekeytomoresubstantivegrowth.•Ourinvestmentconcernsincludeeconomicslowdown,regulatoryrisks,dearthofinnovation,managementqualityandexcessivecapitalinflow.•OurtopstockpicksincludeCtrip(Overweight-V),NetEase(Overweight-V),andTencent(Overweight-V).Seeourrelatedreportsforthesecompanies,plusSina(Equal-weight-V),Sohu(Equal-weight-V),TOMOnline(Equal-weight-V)and51job(Equal-weight-V).•Seepage73foraslidepresentationsummarizingthisreport.ChinaInternetChinaInternet–September12,2005Pleaseseeanalystcertificationandotherimportantdisclosuresstartingonpage113.Page2TableofContents—ReportRoadmapInthisreport,afollowuptoTheChinaInternetReport(4/04),wereviewkeytrendsfortheInternetmarketinChina,relativeanomalies(wecallthem‘mysteries’),pluskeychallengesandrisks.Wealsolayoutourinvestmentframeworkanddrilldownonfourkeysegmentsofthemarket:1)mobilevalue-addedservices(MVAS);2)onlineadvertising;3)onlinegamingand4)onlinecommerce.Inaddition,wehighlightinvestmentideas.Underseparatecover,wehaveinitiatedresearchcoverageofChineseInternetcompaniesCtrip,NetEase,Tencent,Sina,Sohu,TOMOnline,and51job.FormoredetailontheInternetandChina,seeTheChinaInternetReport.InvestmentThesis-FocusonConsumerValuewillDriveShareholderValue...................................................................3ChinaInternetTrends.............................................................................................................................................................41-GrowingFasterThanOtherMarkets…withMorePotential..............................................................................................42-InternetBringsAboutCulturalEvolution.........................................................................................................................53-UnliketheRestoftheWorld,ChinaInternetisMobile-centricRatherThanPC-centric.................................................54-ForeignInterestsAccelerating..........................................................................................................................................65-HotspotforMergersandAcquisitions......................