Investment Highlights

*Immersive Online Experience: *Second Life offers one of the most immersive online experiences with detailed character traits of its avatars among all MMORPGs (Massively Multiplayer Online Role Playing Games). With the acquisition of Windward Mark, a developer of advanced graphic technology, Linden Lab has continued to evolve its graphics on Second Life.

IBM, which had announced a competing conferencing product (LotusLive Connections) in June, is now a beta user of Second Life’s Enterprise product. We believe this underscores superior technology that Second Life offers for 3D conferencing.

*Resilient to the Downturn: *In-world transactions have recovered after a significant drop that started in September 2007, when gambling was banned (Exhibit 3). Despite the downturn (or probably because of it), the number of user hours spent on Second Life has been increasing steadily and is currently at record highs (Exhibit 2).

*Valuation: *We have used three methodologies: a) Multiple of EV/Revenue, b) Target EV based on steady state revenues, normalized net margins, and a growth multiple and c) M&A transaction analysis to arrive at an enterprise valuation of $XX – $XX million for Linden Lab or estimated price per share of approximately $XX – $XX.

Investment Concerns

*Less Favorable Demographics in Developed World: *We estimate that out of the 16.8 million registered users of Second Life, only XX%, i.e. XX users have premium subscriptions. Of these, we estimate that about 80% of the company’s revenue producing user base is in US and Europe – regions where the demographics is increasingly getting older. As the population ages, a significant amount of users could stop using the site actively.

*Younger but Emerging Economies May Offer Limited Near Term Revenue Growth While Hogging Resources: *A majority of recent additions or about XX% of its overall users are from emerging economies
which offer limited near term potential for monetization. Nevertheless, such non-paying users continue to place significant demand on the grid space.

*Possible Impact of Taxation: *Many nations including US, UK, Korea and Sweden are moving towards possibly taxing in-world transactions. As with real world, taxation could dampen economic activity.

*Grid stability issues: *From the company side, there have been significant advances toward ensuring grid stability. In Q1:09, the company reported a total downtime of 0.2%, far better than the nadir of 2.2% in 2007 (Exhibit 31). However, we believe that several million users (15 – 20%) who use older PCs or those with slower bandwidth continue experience problems.