71 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Table 38: Social Networks Users Are Growing Fast, and User Time Is Growing Even Faster Y/Y growth in first nine months ’08 vs ’07; select sites Worldwide US Users, Y/Y Minutes, Y/Y Users, Y/Y Minutes, Y/Y Facebook 170.0% 137.5% 44.8% 31.2% MySpace 9.7% 16.9% 7.8% 23.8% Orkut 47.1% 14.5% 84.7% 82.1% Friendster 57.5% 62.1% 32.5% -6.7% Hi5 66.4% 89.4% 22.6% 33.9% Bebo 45.6% -29.3% 36.1% -54.6% Classmates -3.1% 13.7% 5.6% 20.0% LinkedIn 127.3% 121.8% 170.4% 286.4% All Social Nets 23.9% 32.1% 9.3% 9.3% All Internet 14.3% 9.9% 5.6% 4.5% Source: comScore Networks, J.P. Morgan estimates Key Sites Some of the notable social networking sites worldwide include: • MySpace. Launched August 2003, the site was acquired by News Corporation in July 2005. MySpace’s user base tends to tilt somewhat toward teens and is more US-based than the audience for any of the other big six. Also popular with musicians and bands. • Facebook. Launched February 2004, the site remains independent but in October 2007 drew a $240M investment from Microsoft, which acquired a 1.6% equity stake. Microsoft also sells ads on Facebook. The site became open to non-academic users in September 2006. • Orkut. Launched by Google in January 2004. The site has not taken off significantly in the US but is quite popular in Brazil as well as India and Pakistan. • Friendster. Launched March 2003. In the US, the site has faded somewhat after being an early leader in the space, but it remains quite popular in Southeast Asia. • Bebo. Launched January 2005. The site is popular in the UK and other English-speaking countries, including Ireland, as well as in Poland. In 4Q’07, it announced a partnership with AOL for integration of instant- messenger software; two quarters later AOL acquired Bebo for ~$850B. • Hi5. Launched 2003. The site, though based out of the San Francisco Bay Area, maintains a base of popularity in Latin America as well as in some Asian countries. • Classmates.com. A relative senior citizen in the space, launched in 1995. The site is now part of United Online, and traffic comes primarily from the United States. The site reported over four million paying accounts in 3Q’08, representing 37% Y/Y growth. 72 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com • LinkedIn. Launched 2003. LinkedIn is focused on building professional networks, and, as such, the site has a somewhat more up-market demographic and has had somewhat greater success in selling its ad inventory at higher CPMs. LinkedIn also sells premium memberships. Technology that Fits a Customer Need We think much of the success of social networks is attributable, at heart, to the fact that they provide a superior technology for filling users’ social needs more efficiently. In our 2008 Consumer survey, nearly 80% of social network users indicated that they use the sites to keep in touch with friends, and half noted that they use the sites to reconnect with old friends. Table 39: Users Overwhelmingly Lean on Social Networks to Keep in Touch % among users of social network sites; respondents could choose multiple answers Function % choosing Keep in touch with friends 78.1% Reconnect with old friends 50.5% Share photographs 36.8% Meet new people 29.9% Plan social events 17.7% Share music / find new music 15.2% Play games 14.2% Career networking 10.9% Source: J.P. Morgan Internet Team 2008 Consumer Survey When it comes to filling this user need, we believe social networks have two key competitive advantages over alternative methods of keeping in touch: • News feeds. A news feed is a feature that enables users to see updates on their friends’ lives, and vice versa, without needing to specifically contact each other. As any social network user updates his/her profile, those updates become visible to that user’s circle of friends. • Built-in spam filter. The promise of email is that anyone can contact you, and that has also become its curse. Many proposed spam solutions have focused on attempting to verify that the person contacting you is a friend, but social networks have a built-in verification system that allows one to ensure that the bulk of communication is from confirmed friends. We continue to think social networks are taking away market share from email sites. Last year, we noted that comScore data suggested Y/Y declines in email usage in absolute terms. Through the first nine months of 2008, minutes spent on email sites are growing, though not as quickly as overall Internet usage: 73 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Table 40: comScore Data Indicates Users Are Spending a Smaller Share of Their Time on Email Sites Minutes of usage in millions Worldwide US 9M’07 9M’08 Y/Y 9M’07 9M’08 Y/Y Yahoo 43,565 41,842 -4.0% 21,327 21,256 -0.3% Windows Live Hotmail 33,758 37,970 12.5% 9,425 10,633 12.8% AOL Email 12,556 11,852 -5.6% 12,177 11,482 -5.7% Google Gmail 6,351 7,814 23.0% 1,673 2,287 36.7% All email 110,265 115,154 4.4% 47,025 48,440 3.0% The growth rate of email category is below industry growth rate, both in US and Worldwide All Internet 1,160,692 1,275,400 9.9% 310,837 324,762 4.5% Source: comScore Networks, J.P. Morgan estimates High User Engagement Social network sites excel in their ability to keep users on the site: comScore data indicates that, across the universe of social networking sites, users spend an average of 7 minutes per day, a number that has grown Y/Y; the trend is headed in the other direction with email sites, which are drawing less user time. The effect on email may be partly due to a loss of usage share to social networking sites. Additionally, part of the impact could be related to the sites’ greater efficiency, driven by newer, Ajax-based email platforms. Figure 42: Average Time per User Is Growing on Social Networking Sites and Shrinking for Email Average minutes spent on site, per user per day 6.9 6.7 6.2 7.1 0.0 2.0 4.0 6.0 8.0 All email sites All Social Network sites 9M'07 9M'08 Source: comScore Networks, J.P. Morgan estimates Space Remains Volatile The social networking space remains quite volatile, suggesting other winners may emerge, and some current leaders may fade. Of the 220+ social networking sites ranked by comScore with worldwide time spent data from both 3Q’07 and 3Q’08, sites that grew usage Y/Y outnumbered those where usage shrank by a ratio of 4:3 – a surprisingly large number of decliners in a space where total minutes were up 39% Y/Y in the quarter. 74 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Figure 43: Not Everyone’s Winning: in the US, Slightly More Decliners than Advancers Sites with Y/Y declines in total time spent in 3Q’08, among sites with data in both years 0 25 50 75 100 125 US Worldwide Time on site down Y/Y Time on site up Y/Y Source: comScore Networks, J.P. Morgan estimates Classmates-style Sites Gain in Popularity in Eastern Europe ComScore data suggests that some of the biggest gainers in the space were sites that operate on the Classmates metaphor: as sites that help users track down their former school friends. Such sites appeared to do particularly well in Eastern Europe, with Poland’s Nasza- klasa.pl (“our class”) and Russia’s odnoklasniki.ru (“classmates”) seeing multi-fold usage increases; comScore estimates 3Q’08 worldwide time spent at the two sites was up almost 40x and 5x Y/Y, respectively. In the U.S., where the Classmates model is more mature, the classmates.com site nevertheless appears to be ramping paid usage nicely, with 37% Y/Y growth in 3Q’08 to over 4 million paid accounts. Survey Results: Older Users Remain on the Sidelines Our November 2008 proprietary survey of consumers’ Internet usage patterns reinforced the idea that social networking sites remain primarily the province of younger users. 90% of users aged 18-25 reported visiting a social networking site at least once a month, while only 35% of users 42 or older went to such sites. The results nevertheless represented an increase from the results of our 2007 survey, when only a quarter of users 42 or older reported visiting social networking sites. 75 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Figure 44: Younger Users More Likely to Visit Social Network Sites % of users, in each age group, that reported visiting a social networking site at least once per month 90% 74% 62% 49% 41% 23% 0% 20% 40% 60% 80% 100% 18-25 26-33 34-41 42-49 50-57 58+ Age Source: J.P. Morgan Internet Team 2008 Consumer Survey The age distribution tilts even more heavily to the younger segment due to different usage patterns. Even among the relatively smaller number of older users who reported visiting social networking sites, the majority visited them very occasionally. Among respondents aged 18-33, on the other hand, a third of those who said they visited social networking sites reported visiting once a day or more. Figure 45: Younger Users Tend to Be Heavy Users; Older Users More Likely to Check in Occasionally % among those who report visiting social networking sites 14% 34% 45% 9% 73% 5% 0% 20% 40% 60% 80% 1-4 times a month More than 30 times a month 18-33 34-49 50+ Source: J.P. Morgan Internet Team 2008 Consumer Survey Further, we note that our survey did not include users younger than 18, an age group that, on the whole, tends to be a very heavy user of social networking sites. Privacy Concerns Overblown Many social networking sites, especially Facebook, have faced public criticism for their use of user information. Whether or not these criticisms have merit, from an operational standpoint we believe concerns about privacy are unlikely to hamper the growth of sites. We think history suggests that users are willing to give up incremental information in exchange for features they find useful. Additionally, we think the history of the rollout of news feeds on Facebook is extremely instructive: In September 2006, when the feature was first introduced, it was met with an uproar from users who cited concerns about privacy. In response, 76 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Facebook emphasized that users have the ability to opt out of the feature. A year later, the news feed is one of the central aspects of the Facebook interface, and other sites, including MySpace and LinkedIn, have added similar features. We believe such flare-ups are likely to re-occur. Nevertheless, we believe the track record of social sites’ development suggests users have a strong desire for expression and for an avenue to share what is going on in their lives – and the desire to share is stronger than the desire to hide. Features that meet users’ need for expression are likely to catch on, in our opinion, even if they carry with them an incremental erosion of users’ privacy. Outside of Niche Sites, Monetization May Take Some Time Social networking sites, as a group, have not been able to command very high advertising rates for their page view inventory; the supply of “bulk” page-view inventory from social networks was a contributing factor to the stagnating CPMs for graphical ads over the last two years, and we do not believe demand has yet caught up with this supply. Further, despite a significant degree of effort expended to improve monetization, improvements have been hard to come by, and one of the most successful monetization strategies appears to be to get a guarantee from a search partner, such as MySpace’s $900M partnership with Google. We doubt this can be a successful long-term strategy, however. Google may not offer similarly favorable terms when the deal comes up for renewal in April 2010. As time goes on, we think social networks will develop better targeting and monetization of their page view inventory. Given the wealth of personalized information available to the sites, there is a road map for improved monetization. Nevertheless, the technology remains fairly nascent, and we think the current environment is quite unfavorable for sites without a proven track record to try to attract graphical advertising. Although both MySpace and Facebook have had success generating display ad revenue ($341M in CY’07 display revenue at FIM; press reports put total ’07 revenue at Facebook of $150M), we continue to expect these sites to have trouble growing their effective CPMs over time. Alternatives to the Ad Model May Prove Fruitful Beyond the continued (and thus far minimally effective) push to raise CPMs, we think several other alternatives to the ad-based model exist for social networking. Several sites have pursued one or more of these: • Virtual goods. A site can sell “items” that users send to one another, e.g., a virtual bouquet of flowers on Valentine’s Day or a virtual balloon for graduation. Such goods are also popular on some virtual world sites. • Paid Premium memberships. Sites like LinkedIn and Classmates.com offer these; at LinkedIn, paid accounts have greater access to users outside their immediate network, whereas at Classmates the premium memberships entitle users to have greater communication privileges with other members 77 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com as well as a variety of other perks. As of 3Q’08, subscription revenue represented ~64% of the total revenue for UNTD’s Classmates segment. • Classifieds. Unlike a normal classified site, the level of trust can be higher because buyer and seller can see the link between them. In our 2008 Internet survey, social network users were users of classified sites at a higher rate than those who had not used social network sites. Classified advertising is rapidly migrating online from newspapers, and the NAA estimates the newspaper classified market, over $14B in F’07, declined 28% Y/Y through the first nine months of F’08. • eCommerce. Sites may try to use the personal data available to them for better-targeted eCommerce. Even though we are usually skeptical of the salience of privacy concerns, we think direct sales could prove difficult. Further, “Recommendations from friends/relatives” has been the least popular factor driving shoppers to pick a store in both years of our Internet survey, with only 21% ranking it in their top 5 factors in 2008. That said, even a small sliver of the eCommerce market, which we project at $460B worldwide in F’09, could be valuable. • A la carte paid features. Sites may offer the ability to, e.g., post a limited number of photos for free, and a large quantity (or at a higher quality) for a paid membership. • Lead generation. For users who have uploaded photos, a site may try to form a partnership with a printer to enable quicker ordering of prints. A site may partner with iTunes or Amazon to enable users to buy MP3s shared by their friends. • Paid applications. Thus far, social networks have welcomed apps onto their platforms in order to build user engagement. In the future, social sites may try to charge the operators of the apps for access to the networks’ superior stream of traffic. Alternatively, they may make the applications paid-for by users, and split the revenue with the app developers. 78 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Online Music Primer Online music landscape changed in ’08 As iTunes continued to dominate online music distribution, some of its competitors appeared to have re-thought the attractiveness of the stand-alone subscription-based model. In the course of ’08, Yahoo! discontinued Yahoo! Music, and Napster introduced DRM-free downloads and subsequently was acquired by Best Buy. The other significant remaining player, Rhapsody America, the joint venture between RealNetworks and MTV Networks, remained committed to growing its online subscription music business and stepped up promotional spending. Yahoo! Music Discontinued The service, which was launched on May 11th, 2005, was discontinued on September 30th, 2008. Yahoo! Music subscribers could choose to transfer to a Rhapsody America subscription. However, as RealNetworks commented on its 3Q’08 earnings call, the number of subscribers actually migrating to Rhapsody was below expectations. Napster Acquired by Best Buy Napster added DRM-free downloads to its subscription offering in May ’08. On September 14, 2008, Best Buy and Napster signed a merger agreement; the acquisition closed on October 30, 2008. Rhapsody America Remains Committed to the Business Model Rhapsody America, the joint venture between RealNetworks and MTV Networks, remained committed to the online music subscription model. As Yahoo! Music was discontinued and Napster agreed to be acquired by Best Buy, Rhapsody increased promotional spending aimed at growing its subscriber base. Figure 46: RealNetworks Continues to Spend on Promoting Its Subscription Offering $ in millions 7.3 9.2 15.2 18.0 0.0 5.0 10.0 15.0 20.0 Q1-08A Q2-08A Q3-08A Q4-08E Source: Company reports and J.P. Morgan estimates. Represents advertising on MTV Networks. Launch of MySpace Music Shifts Focus to Social Networks On September 25, 2008 MySpace launched MySpace Music, a joint venture between MySpace and four major music labels, including EMI Music, Universal Music, Sony BMG and Warner Music. The offering includes free unlimited streaming and song 79 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com downloads to own through Amazon MP3. Free streaming music will be monetized by selling advertising. We believe the launch of MySpace Music will put additional competitive pressure on subscription-based offerings, particularly on Rhapsody America, as availability of a free substitute to a large potential user base will impact subscriber acquisition (Rhapsody offers 25 free streams a month to Facebook users before requiring a subscription). Figure 47: MySpace Music Reaches 73 Million Monthly Unique Visitors in the US 41,416 73,035 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 MySpace Facebook Source: comScore Media Networks. Pure Play Music Distribution Model Will Likely Continue to Face Challenges in ’09 We remain cautious on the outlook for pure play subscription music offerings in the coming year: • We continue to believe hardware as opposed to software is where margin gains will be seen, as illustrated by a positive margin for iPod and near breakeven profitability of iTunes. • Launch of MySpace Music with its advertising supported unlimited streaming adds another competitive headwind in the market which already is dominated by iTunes. 80 Global Equity Research 05 Januar y 2009 Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Online Music Distribution Landscape The table below contains main online music offerings as of year-end ’08. Table 41: Online music offerings Company Description AllOfMP3 & MP3Sparks AllOfMP3 and MP3Sparks are prepaid online music download store operated by Mediaservices, Inc. Since June 17, 2008, the original AllOfMp3 site has been closed and replaced by a blog due to certain legal issues, but the MP3Sparks is still a fully operational music download store. Amazon MP3 Amazon MP3 is a music download service offering DRM-Free MP3 formatted over 5 million songs and albums. Audio Lunchbox Audio Lunchbox is a music download service, with more than 2 million songs, all in DRM free MP3 format. Each album page includes the artist, label, genre and release. BuyMusic BuyMusic is a music download service, with 1 million songs in catalog. eMusic eMusic is a subscription-based music download service that offers more than 4.5 million DRM-Free MP3 formatted titles. Unlike most subscription services, the songs you download can be used anywhere you like. Even if you cancel your subscription, there is no expiration date on your music. Facebook Music The Facebook Music Service was launched in August 2007 but was quickly slated. However, according to press reports, Facebook is talking to a number of song-streaming services and music community sites that own licenses to distribute music or have a proprietary service, including Rhapsody, iMeem, iLike and Lala, about an outsourcing deal that would more deeply integrate their music experience into Facebook. IMeem IMeem is a music download service. Users, once registered, can stream as many on- demand songs as they want for free without running into any sort of playback limitations. iLike.com iLike is a website that allows users to download and share music, a website still in a beta version, but is open to anyone. iTunes iTunes is a music download service. It has a free software application for Mac and Windows with most of its music downloaded coming in an AAC format, which only plays on the iTunes Digital Jukebox or on an iPod. Although Apple is in negotiations with the music studios to open their file formats, their current selection of MP3 DRM free music, known as iTunes Plus, is limited. Lala LaLa offers music download service; users can play any song only once by registering. After the song has been played once, they must purchase it to play it again. MSN Music MSN's music purchasers are being redirected to either the Zune Marketplace or to RealNetworks' Rhapsody site, starting November 14, 2006. Myspace Music MySpace Music is a new digital service joint venture between MySpace and big four media companies - EMI Music, Universal Music, Sony BMG and Warner Music - announced on April 3, 2008. MySpace Music offers 5 million songs for free web streaming or for purchase. Napster Napster offers download and subscription service with more than 6 million DRM free MP3 formated songs. On Sep 15, 2008, Best Buy acquired 90% stake in Napster for $121 million PayPlay.FM PayPlay.FM is an independent music download site that offers DRM protected WMA and DRM free MP3 titles. PlayPlay specializes in independent music and has about 2 million songs. Puretracks Puretracks is a music download site. It has about 1.3 million songs in WMA and MP3 formats, and many of the albums do not include biographies. Originally a Canadian site, but now offers in U.S. Rhapsody Rhapsody offers subscription and download options. The newest addition to the Rhapsody family is the MP3 Store. All tracks and albums sold in the MP3 store are DRM- Free and can be used anywhere. Rhapsody has more than 5 million titles in its library. Wal-Mart Music Wal-Mart Music Store is a music download service. It offers more than 2.5 million MP3 formatted tracks. Wal-Mart's MP3 model ensures all popular media players will work with its service, including iPod and Zune. Yahoo Music Unlimited Yahoo! Music Unlimited was an on-demand, online music service launched on May 11, 2005 and provided by Yahoo! Music. The service was discontinued on September 30th, 2008. Existing subscribers are being migrated to Real Rhapsody. Zune Marketplace Zune Marketplace offers subscription and download options with more than 3 million songs. Most songs are available in protected ZPL format, meaning they are only compatible with Microsoft's Zune player. Zune does have a small selection of DRM-Free tracks. Source: Company websites, Wikipedia, music-download-review.toptenreviews.com. . 23% 0% 20% 40% 60% 80 % 100% 18- 25 26-33 34-41 42-49 50-57 58+ Age Source: J.P. Morgan Internet Team 20 08 Consumer Survey The age distribution tilts even. 9M’ 08 Y/Y 9M’07 9M’ 08 Y/Y Yahoo 43,565 41 ,84 2 -4.0% 21,327 21,256 -0.3% Windows Live Hotmail 33,7 58 37,970 12.5% 9,425 10,633 12 .8% AOL Email 12,556 11 ,85 2