4/28/2003AOL/Legend JV AOL © and Legend Group © : A Joint Venture in China Derek Chen, Justin Choi, Robert Kynchalski, Matthew Kwan Lee Topics in Emerging.

4/28/2003 AOL/Legend JV

AOL© and Legend Group©: A Joint Venture in China

Derek Chen, Justin Choi, Robert Kynchalski, Matthew Kwan Lee

Topics in Emerging Markets – Professor J.P. Mei

A Case for Building a Market for Internet Service Providers

http://www.aol.com/ams/clickThruRedirect.adp?1073746720,2147506778x2147491540,http://www.aol.com

http://webmail.aol.com/

http://webcenter.shop.aol.com/main.adp

http://my.screenname.aol.com/_cqr/logout/mcLogout.tmpl?siteId=myaolPROD&siteState=OrigUrl%3Dhttp%253A%252F%252Fmy.aol.com

http://www.legend-holdings.com/images/index_right/LegendCEOinterview.pdf

http://business.china.com/


Introduction• The AOL/Legend Story

– Company Background and Financial Data– Specifics of JV into China for ISP services

• Analysis of the JV– Political, Economic, and Social Situation– Financial Analysis: Stock Price, Debt

Bonds & Yields, NPV Analysis & Discounted Cash Flow

– Country Risk and Valuation: Salomon Smith Barney Emerging Markets Equity Allocator

• Final Recommendation– SWOT Analysis– The Actual Aftermath of the AOL/Legend

JV








A Look At The Players…

– Founded in 1981, Legend become the dominant force in China’s PC market by 1997 with an over 30% market share in hardware & software

– The move into ISP services, started in 2000, as a way to ensure market dominance and create long-term stability•Capitalization on growing interest in

the Internet•Facilitate technological growth and

development in China

•Legend Group, LTD.









3/31/2000

3/31/2001

ASSETS

Inventories 1,766,899

2,101,112

Acct. Receivable 1,206,814

1,745,852

Dep./Prepay/Otr. 352,809 415,042

Cash Equivalents 2,180,197

2,633,651

Total Current Assets

5,506,719

6,895,657

Land/Buildings 219,713 269,484

Leasehold Improvements

91,619 81,545

Plant/Machinery 233,843 255,899

Furniture 9,859 3,987

Prop & Equip 240.925 621,963

L.T. Investments 126,934 214,755

Depreciation -237,119 -315,317

Intangibles 1,887,850

0

Total Assets 8,080,343

8,027,993

•Legend Group, LTD.3/31/2000 3/31/2001

LIABILITIES

Acct. Payable 1,939,289 2,278,804

Accruals 621,383 947,165

Proposed Div. 133,510 989,730

Trust Receipt 2,297 0

Taxes Payable 2,818 11,822

Curr. Port. LTD 189,446 816,709

Total Current Liab.

2,888,742 5,044,230

Total Long Term Debt

140,275 15,760

Deferred Taxes 9,859 3,987

Other LT Liabs. 240.925 621,963

Total Liabilities 3,040,165 5,134,801

Total Equity 5,040,178 2,893,192

Shares Outstanding 7,417,203.52

7,513,962.11

Current Ratio = 1.367039

Quick Ratio = 0.950501

ITO = 8.305

DSO = 36

Debt Ratio = 0.1963%

EPS = $.67









– The most widely used ISP service in North America with 29 million subscribers

– JV as “extraordinary opportunity for both of our companies to make the most of the incredible potential of the Chinese Internet market” – AOL President Michael Lynton

– Relying on brand equity and solid technological base to provide content and capital to the ISP sector in China

– Has the financial capability to participate in JV and expand its global market

•America Online (AOL Time Warner)








A Look At The Players…•AOL Financial Summary

– 3% Revenue increase from December 2000 to June 2001 (from $8.9 billion to $9.2 billion)

– EBITDA at 20% growth, EPS up 28%– Current Ratio at .84– Quick Ratio at .70– DSO decreased in 1st half of 2001 from 126

to 111

Even with AOL financial stability, this is not enough to determine the long-term effects of the JV








The AOL/Legend JV in China• June 11, 2001: JV announced as “the first

important milestone toward delivery of AOL services to the Chinese mainland” for the purpose of capitalizing on the growing market for Internet services

• The Financing of the JV– US$200 million divided evenly between

AOL and Legend (US$100 million each)– Large potential market of 22 million in

China– Internet penetration growth rate: 2%

• Examples of Impediments for Entering China– Government restrictions and regulations on

stock and expansion– Chinese-language conversion– Education of consumer target market base– Competition from new entrants into the

market

• Industry Speculation and Concerns– Privacy and free speech on content

regulation– Previous failure of AOL HK with

Chinadotcom– Superior market dominance or potential

saturation?







http://news.china.com/zh_cn/focus/sars/




Political Concerns and Barriers

– Presence of corruption in the CCP, led by President Jiang Zemin

– Government restriction that domestic company must have a controlling share (51%) for JV’s

– Traditional restrictions on freedom of speech, causing concerns over content regulation

– Even with entry into the WTO, political tension between the US and China has elevated in recent years

• Functioning in the Communist Government








http://taigeer.china.com/


Economic Issues and Barriers

– With entrance into the WTO, economic opportunity for foreign trade and investment

– 2001 GDP per capita of US$4,300– Continuing issue of misallocation of

resources to the state sector at expense of private enterprise•Economic disparity vs. sustainable

growth in living standards•“Internet user” monthly income per

capita US$128•Dependency on Agricultural economy

• The Changing Face of the Chinese Economy








Social Climate and Concerns

– Total Population of 1.3 billion as of 2000, approximately 20% (200 million+) living on under US$1 per day

– Target population for ISP services: 16-64 age demographic (888 million)

– Income inequality as a result of a rural-dominated society

– Illiteracy decline in last decade from 15% to 6%• Fails to put to rest consumer

education problems– Internet users at 26 million in 2001

• Chinese Society Continues to Struggle








Financial Analysis• Stock Price of Legend Group Limited

Legend Group Limited Stock Price '01-'02

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“Investors generally do not believe Legend will far exceed the market consensus this time … we [Credit Suisse First Boston] on the other hand, believe this is a great time to accumulate.” – CSFB, 6/01








Financial Analysis• Stock Price of AOL Time Warner

– A tepid global economic situation– Internet popularity decline after the

burst of the dot-com bubble– Negative initial market reaction to the

AOL merger with TimeWarner– Competition with new entrants and local

service providers in the ISP market

AOL Time Warner Stock Price '01-'02

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Due to the factors listed before as well as AOL’s status as a large multinational conglomerate, it is difficult to determine exactly how much AOL’s JV with Legend affected stock price before and after the announcement.








Financial Analysis• Debt Yields and Bonds

– China technology bonds listed as “BBB” rated•6-12 month maturity bonds with

yield of 4.414%, growing proportionately with maturity date

– Legend risk exposure small – debt to equity ratio less than 1%•EPS up US$0.026 and growth rate

down 47.7% at 22.5%Legend should raise its yield higher than

a comparable bond of the same maturity








Financial Analysis• NPV and Discounted Cash Flow Analysis– Cash flows and NPV not obtained for our

project and analysis•The project is still in the research and

development phase•The cash flow projection of $200

million over time has not been specified by either of the participating firms

• JV put on hold by both companies now– AOL to be looked at separately from

TimeWarner since it is more risky (higher beta and lower debt financing)








Financial Analysis• Country Valuation– China price-to-earnings ratio is still high for

an emerging market to operate successfully•Average at 1.2x while China stands at 1.6x•For “trailing” price-to-earnings ratio,

China scored 12.5 with the average at 17x•Forecasted price-to-earnings ratio fell

from 12x to 9x– Earnings yield minus real short-term yields

where China outperforms benchmark of 270 basis points







http://www.cnc.ac.cn/gb/news/news_import/200303240015.html

http://www.sinofile.com/


Financial Analysis• Country Risk Analysis

– Forecasted earnings growth rate well below average of 19% for emerging markets at 5%

– High overall beta country risk of 1.45– Interest rate rapidly falling following JV

announcement– Overall poor investment environment in

China as of October 2001•Real exchange rate valuation at 8%•2% current account balance relative to

GDP







http://www.cnc.ac.cn/gb/news/news_import/200303240015.html

http://www.sinofile.com/


Final Recommendation

Strengths

•More receptive trade relations

•Brand recognition

•Growing Chinese Technology Base

Weaknesses

•Gov’t Sanctions•Failure of AOL HK in year prior•Poor investing opportunity in China•Minimal Support•JV in R&D

Opportunities

•Large potential market

•Internet growth in China

•China entrance into WTO

• SWOT Analysis

Threats

•Education of Chinese population•Threat of new entrants•Financial stability•Economic disparity among sectors








Final Recommendation• Our Group Analysis

– We recommend that the JV be put on hold or even abandoned as a result of our financial research and analysis• Falling stock price of both firms• China’s looming negativity on Legend’s

control over the dying PC market• Market indicators show increasing risk,

putting growth into serious question• Continuing liquidity depletion in China• Legend’s low ISP retention rate• Lack of affordability and marketing focus








Final Recommendation• The Actual Aftermath of the AOL/Legend JV– AOL/Legend “Flying Dragon” service plan

•“Tight lipped over rollout schedules and content plans…” – Top Management

•Speculation of additional capital needed beyond $100 million from each firm

– Cautious treading by AOL/Legend has led to industry speculation that the JV will be terminated• JV put on hold by both firms in April 2003,

confirming our analysis recommendation








Any Questions?







4/28/2003AOL/Legend JV AOL © and Legend Group © : A Joint Venture in China Derek Chen, Justin Choi, Robert Kynchalski, Matthew Kwan Lee Topics in Emerging.

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