China Stock Research  July 2007

n          Sell Rating TOM Online Inc. (Nasdaq: TOMO) is a leading wireless Internet company in China. We recommend a sell rating for the following reasons: Weakening Financial Performance has deteriorated since 2007 l                     In Q2 2007, total revenues were US$34.39 million, a decrease of 30.4% from Q2 2006 and a decrease of 2.1% from the last quarter. This was attributable to the shrinking Wireless Internet Services Business. l                     Net loss of US$9.56 million for 2Q07 occurred, compared to net income of US$11.75 million in 2Q06 and net income of US$0.15 million in 1Q07. Damaged Positioning by Competitor’s Strategic Move l                     China Mobile has excluded promotion for all wireless value-added service products of its competitors’ including TOMO’ from the menu embedded in mobile handsets produced by selected mobile phone producers who have formed strategic alliance with China Mobile. This move had and will damage TOMO’s Wireless Internet Service Business. Share Price Inflated by Premium for the Possible Privatization l                     On March 3, 2007, TOMO’s share price jumped by 26.76% from $11.62 to $14.73 in response to a proposed conditional privatisation of TOM Online l                     Shares are trading at 20.7% premium over price pre-announcement price of $11.62. l                     Failure of privatization will put price down significantly The Success of the Newly Established Joint Venture Eachnet is Uncertain l                     In Q2 2007, the accumulated share of loss from Eahcnet was US$6,426 thousand, representing 12 times of investment cost of US$527 thousand by TOMO. Increasing Burden of Debt Obligation in 2008 and 2009 l                     In 2007, TOMO extended a bank loan US$35.34mn to year 2009 which was due in 2006. l                     In 2008 and 2009, there will be $10.9mn and $80.03mn debts fall due US$20mn contracted but not yet paid contingent liabilities payable to Eachnet Company Description TOM Online Inc. (Nasdaq: TOMO, Hong Kong GEM: 8282) is a leading wireless Internet company in China providing value-added multimedia products and services mainly to the young demographics. The company’s primary business activities include wireless value-added services and online advertising. The company offers an array of services such as SMS, MMS, WAP, wireless IVR (interactive voice response) services, content channels, search and classified information, and free and fee-based advanced email.   Reasons for SELL Rating 1.                 Weakening Financial Performance has deteriorated since 2007 Since 2004, gross margin, operating margin and net margin has delivered a decreasing trend, which was accelerated in 2006. From 2004 to 2006, gross margin fell 10.14% to 37.09%, and operating income and net income plunged 7.67% to 17.65% and 10.61% to 17.02% respectively. Financial problems became more significant from 2007. In Q2 2007, total revenues were US$34.39 million, a decrease of 30.4% from Q2 2006 and a decrease of 2.1% from the last quarter. Wireless Internet service revenues were US$30.24 million, representing a 32.9% decrease from Q2 2006 and a 5.0% decrease from the previous quarter. The shrinking Wireless Internet service business which represents 87.9% of total quarterly revenue signifies a problematic prospect of TOMO. Consequently, there was a net loss of US$9.56 million for 2Q07 compared to net income of US$11.75 million in 2Q06 and net income of US$0.15 million in 1Q07. Excluding goodwill impairment charge of US$6.82 million, Non-GAAP net loss was US$2.74 million. Although online advertising revenues increased 27% quarter-over-quarter to US$3.38 mn, it represented a 13.2% decrease from Q2 2006 and it made up only 9.8% of our total quarterly revenues. Further, as a result of poor operating performance, CFOs fell from US$53,878 thousand in Q4 2006 to US$8,735 thousand in Q1 2007 and US$7,034 thousand in Q2 2007. The fallen CFOs have forced TOMO to slow down investments. Hence, CFIs fell from US$66566 thousand in Q4 2006 to US$1783 thousand in Q1 2007 and US$1690 thousand in Q2 2007. 2.Damaged Positioning by Competitor’s Strategic Move In May 2007, China Mobile introduced a new practice of sending fee reminders to its WAP service users when they request downloads of WAP pages onto their mobile handsets and seeking their confirmation before such download requests are processed. Furthermore, in the past, China Mobile entered into its own strategic alliances with selected mobile phone producers pursuant to which it embedded menus in their handsets for all the best-selling products on China Mobile’s Monternet wireless portal, including certain of TOMO’s products. However, in May 2007, China Mobile started to promote solely its wireless value-added service products in such menus. These policies had and will cause an adverse effect on our wireless Internet business, in particular WAP business in 2Q07 and beyond. The damages of China Mobile’s new strategy are an additional problem adding to TOMO’s already slowing down growth. Thus, its prospect is not optimistic. 3. Share Price has Reflected Premium for the Possible Privatization During the past half year, TOMO was underperforming compared with NASDAQ index. On March 3, 2007, TOMO’s share price jumped by 26.76% from $11.62 to $14.73 in response to a proposed conditional privatisation of TOM Online. Afterwards, the trading range was between $13.16 and $15.56, and currently is around $14, representing a premium of 20.5% compared with prior-privatisation attempt. Considering the difficulties faced with Tom online, if the privatization does not proceed, the price will fall significantly. 4. The Success of the Newly Established Joint Venture Eachnet is Uncertain The joint venture, Tom Eachnet was formed by Tom online and eBay International AG (“eBay”) on December 20, 2006. In Q2 2007, the accumulated share of loss from Eahcnet after adjusting for foreign exchange gain of US$76 thousand was US$6,426 thousand, representing 12 times of investment cost of US$527 thousand by TOMO. Hence, it will still take time to turn Eachnet into a profitable investment. 5.  Large Amount of Debt is Falling Due and Existence of Contingent Liabilities Raise Concern of Refinancing In May 2007, a secured bank loan of US$35,340,000 was extended to be repaid on or before August 12, 2009 from the original repayable date on June 2, 2006. This record of default combined with TOMO’s deteriorating situation has raised a concern of its capability of meeting debts that fall due in 2008 and 2009. In addition to the US$35.34 million secured bank loan, US$55,271,000, of US$9,500,000 of US$55,271,000 secured bank loan will mature in March 2008 and the remaining US$45,771,000 will be repaid on or before April 28, 2009. Besides, TOMO is contracted to provide a shareholder’s loan of US$20 million, bearing interest at 1.3% over London Inter-Bank Offered Rate (“LIBOR”), to TOM Eachnet when the remaining cash balance of TOM Eachnet is only enough to finance no more than six months of its operation. In spite of large amount of debts falling due, at the end of Q2 2007, TOMO was holding $118.8 million cash and bank loans are secured with available-for-sale securities, thus the solvency problem is a potential, but not yet a severe issue. Table 1: TOM Online, Inc. - Annual Income Statement, 2002-2006 (CNY, in millions)   Table 2: TOM Onlne, Inc – Balance Sheet, 2002-2006 (CNY, in millions)   Table 3: TOMO Online, Inc– Cash Flow Statement, 2002-2006 (CNY, in millions) To access latest stock research and other research content, please register!