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AOL and Legend Group :
A Joint Venture in China
A Case for Building a Market for Internet Service
Providers
Derek Chen, Justin Choi, Robert Kynchalski, Matthew Kwan Lee
Topics in Emerging Markets – Professor J.P. Mei
4/28/2003
AOL/Legend JV
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
4/28/2003
AOL/Legend JV
A Look At The Players…
•Legend Group, LTD.
– 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
4/28/2003
AOL/Legend JV
A Look At The Players…
•Legend Group, LTD.
3/31/2000
3/31/2001
Acct. Receivable
Dep./Prepay/Otr.
Cash Equivalents
2,101,112
1,939,289
2,278,804
621,383
947,165
352,809
415,042
Proposed Div.
133,510
989,730
2,180,197
2,633,651
Trust Receipt
2,297
0
Taxes Payable
2,818
11,822
Quick Ratio = 0.950501
Land/Buildings
DSO = 36
Furniture
Acct. Payable
Accruals
Current
= 1.367039
1,206,814 Ratio
1,745,852
ITO
= 8.3056,895,657
5,506,719
Plant/Machinery
4/28/2003
1,766,899
Total Current Assets
Leasehold
Improvements
3/31/2001
LIABILITIES
ASSETS
Inventories
3/31/2000
219,713
269,484
Curr. Port. LTD
189,446
816,709
91,619
81,545
Total Current Liab.
2,888,742
5,044,230
140,275
15,760
Deferred Taxes
9,859
3,987
Total Long Term
Debt Ratio = 0.1963%
233,843
255,899
EPS
9,859= $.673,987
Debt
Prop & Equip
240.925
621,963
Other LT Liabs.
240.925
621,963
L.T. Investments
126,934
214,755
Total Liabilities
3,040,165
5,134,801
Depreciation
-237,119
-315,317
Total Equity
5,040,178
2,893,192
Intangibles
1,887,850
0
Shares Outstanding
7,417,203.52
7,513,962.11
Total Assets
8,080,343
8,027,993
AOL/Legend JV
A Look At The Players…
•America Online (AOL Time Warner)
– 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
4/28/2003
AOL/Legend JV
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
4/28/2003
AOL/Legend 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
••Industry
The
Examples
Financing
Speculation
of Impediments
of the JV
and Concerns
for Entering China
–– Privacy
US$200
Government
and
million
free
restrictions
divided
speechevenly
on
and
content
regulations
between AOL
on
and
regulation
stock
Legend
and expansion
(US$100 million each)
–– Previous
Large
Chinese-language
potential
failuremarket
of AOL
conversion
of
HK
22with
million
Chinadotcom
in China
–– Superior
Internet
Education
penetration
market
of consumer
dominance
growth
target
rate:
or market
potential
2% base
– saturation?
Competition from new entrants into the
market
4/28/2003
AOL/Legend JV
Political Concerns and Barriers
• Functioning in the Communist Government
– 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
4/28/2003
AOL/Legend JV
Economic Issues and Barriers
• The Changing Face of the Chinese Economy
– 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
4/28/2003
AOL/Legend JV
Social Climate and Concerns
4/28/2003
• Chinese Society Continues to Struggle
– 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 ruraldominated 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
AOL/Legend JV
Financial Analysis
• Stock Price of Legend Group Limited
Legend Group Limited
Stock Price '01-'02
“Investors generally do not believe Legend will
70
far exceed the market consensus this time …
60
we [Credit Suisse First Boston] on the other
50
40
Stock Price
hand, believe this is a great time to
30
accumulate.” – CSFB, 6/01
20
80
10
Mar
Feb
Jan
Dec
Nov
Oct
Sep
Aug
Jul
Jun
May
Apr
Mar
Feb
Jan
0
Month
4/28/2003
AOL/Legend JV
Financial Analysis
Mar
Feb
Jan
Dec
Nov
Oct
Sep
Aug
Jul
Jun
May
Apr
Mar
Feb
Jan
• Stock Price of AOL Time Warner
AOL Time Warnersituation
– A tepid global economic
Stock Price '01-'02
– Internet popularity decline after the burst of
60
thetodot-com
bubble
Due
the factors
listed before as well as
50
status
asmarket
a largereaction
multinational
– AOL’s
Negative
initial
to the AOL
40
Stock Price
conglomerate,
it
is
difficult
to
determine
merger
with
TimeWarner
30
exactly how much AOL’s JV with Legend
20– Competition with new entrants and local
affected
stock price
after the
10
service providers
in before
the ISPand
market
announcement.
0
Month
4/28/2003
AOL/Legend JV
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
4/28/2003
AOL/Legend JV
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)
4/28/2003
AOL/Legend JV
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
4/28/2003
AOL/Legend JV
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
4/28/2003
AOL/Legend JV
Final Recommendation
• SWOT Analysis
Strengths
•More
receptive
trade
relations
•Brand
recognition
•Growing
Chinese
Technology
Base
4/28/2003
Weaknesses
Opportunities
•Gov’t
Sanctions
•Failure of
AOL HK in
year prior
•Poor
investing
opportunity
in China
•Minimal
Support
•JV in R&D
•Large
potential
market
•Internet
growth in
China
•China
entrance into
WTO
Threats
•Education
of Chinese
population
•Threat of
new
entrants
•Financial
stability
•Economic
disparity
among
sectors
AOL/Legend JV
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
4/28/2003
AOL/Legend JV
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
4/28/2003
AOL/Legend JV
Any Questions?
4/28/2003
AOL/Legend JV