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CommentPleaseseeanalystcertificationandotherimportantdisclosuresstartingonpage113.Page1IndustryEquityResearchGlobalMorganStanleydoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.IndustryOverviewSeptember12,2005RichardJi(Internet/Media-China)+85228486926–HongKongRichard.Ji@morganstanley.comMaryMeeker(Internet-US/Global)+1-2127618042–NewYork/MenloParkMary.Meeker@morganstanley.comCreatingConsumerValueinDigitalChinaContributors:AndyXie(Economics-China)andy.xie@morganstanley.comMarkShuper(Telecom-China)mark.shuper@morganstanley.comHaniAbuali(Telecom-China)hani.abuali@morganstanley.comLinaChoi(Telecom-China)lina.choi@morganstanley.comViktorMa(Technology-China)viktor.ma@morganstanley.comBrianFitzgerald(US-Internet)brian.fitzgerald@morganstanley.comRamjiSrinivasan(US-Internet)ramji.srinivasan@morganstanley.comJennyWu(China-Internet/Media)jenny.wu@morganstanley.comAllofMorganStanley’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......................