China / Hong Kong Industry Focus Hong Kong Telecom Sector Mobile operators also launched various top-up plans to improve mobile ARPU. HT launched a new “Top Up Data Pack” at an

www.dbsvickers.com

ed-TH / sa- PY

Winning through effective pricing strategy

Mobile operators remain disciplined in mobile data pricing, positive to ARPU and service revenue growth

Downside risk from handset sales due to weak iPhone 6S demand in HK, triggering downward earnings revisions

HKBN gained market share as revealed by its better-than-expected FY8/15 results; expect more aggressive pricing going forward

Prefer HKBN and SmarTone, who are smaller players and gaining market share with strong capability in strategy execution

Mobile service revenue growth offset by handset sales decline. Hong Kong mobile operators remain disciplined in mobile data pricing, which is positive to mobile ARPU and service revenue growth. Operators have recently been focusing more on raising tariffs for lower-tier plans as well as launching various top-up plans to monetise more data usage. But we saw limited tariff hike for the higher-tier plans in the past few months. On the other hand, the demand for iPhone 6S is weaker than iPhone 6 in Hong Kong. This suggests a possible downside risk in handset sales and therefore downward earnings revisions.

HKBN successfully gained market share; expect more aggressive pricing to follow. The competition in the residential broadband market started to heat up early this year, and we believe it was initiated by HKBN (1310 HK, BUY). It successfully gained market share with 62k net-adds in FY8/15 with 5% ARPU increase. While we notice that HKT (6823 HK, HOLD) and other smaller players also responded by lowering their prices, HKBN appears to be the winner through tactical pricing strategies. We expect more aggressive pricing from HKBN going forward.

We like HKBN and SMT. HKBN and SmarTone (SMT, 315 HK, BUY) are smaller players with strong execution ability in their residential broadband and mobile markets respectively. They have been able to gain market shares. We believe that HKBN is on track to achieve its target of 300k sub net-adds in FY8/15-FY8/19F, which will support 20%+ p.a. dividend growth in the coming few years. Maintain BUY on HKBN with a TP of HK$11.0. SMT, being a smaller player focusing on high-end subs, started to penetrate into specific lower-tier segment a few years back. It has successfully added a new revenue stream. Maintain BUY on SMT with a TP of HK$15.0.

HSI : 22,068

ANALYST Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected]

Recommendation & valuation

Company Pric e T argetPric e

Rec M k tCap

F Y 15FPE

HK $ HK $ US$m x

Hong K ong T elec om operat o rsHKBN(1310 HK)

10.2 11.0 Buy 1,324 98.4

HKT Trust(6823 HK)

9.72 9.1 Hold 9,496 22.8

Hutchison Telecom(215 HK)

2.78 2.7 Hold 1,729 14.8

Smartone Telecom(315 HK)

11.74 15.0 Buy 1,606 13.2

Source: Thomson Reuters, DBS Vickers

DBS Group Research . Equity 27 November 2015

China / Hong Kong Industry Focus

Hong Kong Telecom Sector Refer to important disclosures at the end of this report

Industry Focus

Hong Kong Telecom Sector

Page 2

Mobile market

Expect ARPU improvement through the tariff hike on lower-tier plans and launch of top-up plans

Hong Kong mobile operators remain disciplined in mobile data pricing, recently focusing more on raising the tariffs for lower-tier plans to narrow the price gap between lower-tier and high-tier plans to minimise the risk of trade downs. Accordingly we did not see much tariff hike for the high-tier plans, during the launch of iPhone 6S. They also launched various top-up plans to monetise more data usage. On the other hand, mobile roaming revenue continues to weigh on service revenue.

SMT took the lead to further raise the price for the 3G speed-capped plan from HK$78 to HK$88 per month in Jun 2015, and this was followed by China Mobile Hong Kong (CMHK) and HKT. On the other hand, Hutchison Telecom (HT, 215 HK,

HOLD) raised tariffs of its 4G SIM-only plans by HK$20-30 per month to narrow the pricing discounts to its major competitors - HKT and SMT.

Mobile operators also launched various top-up plans to improve mobile ARPU. HT launched a new “Top Up Data Pack” at an additional HK$40 per month for 1Gb or HK$70 per month for 2.5Gb. HKT started offering a top-up plan of HK$150 for an additional 10Gb for its 10Gb plan subs. SMT also increased the price of its unlimited data top-up plan from HK$128 to HK$148, which was launched last year.

On a negative note, roaming revenue decline will continue to drag down mobile service revenue. In terms of contribution to mobile service revenue, SMT’s FY6/15 and HT’s FY14 roaming revenues accounted for 15% and 25% of the mobile service revenue respectively. We expect roaming contribution to continue to decline in the coming years.

Top-up plans of Hong Kong mobile operators

Da ta p l a n u s e r(p e r mo n th ) SM T 3 HK CM HK c s l . 1 0 1 01Gb User HK$50/Gb HK$38 /200MB

**HK$40 /1GbHK$30 /0.5Gb HK$28 /200MB

HK$50 /1GbHK$28 /200MB

HK$50 /1Gb

2.5Gb User HK$50/Gb HK$38 /200MB**HK$40 /1Gb

**HK$70 /2.5Gb

HK$30 /0.5Gb HK$28 /200MBHK$50 /1Gb

HK$28 /200MBHK$50 /1Gb

6Gb User HK$50/Gb**HK$148 for unlimited

data (subjected to Fa irUsage Policy)

HK$38 /200MB**HK$40 /1Gb

**HK$70 /2.5Gb**HK$150 /6Gb

HK$30 /1Gb HK$28 /200MBHK$50 /1Gb

HK$28 /200MBHK$50 /1Gb

10 Gb User HK$50/Gb**HK$148 for unlimited

data (subjected to Fa irUsage Policy)

HK$38 /200MB**HK$40 /1Gb

**HK$70 /2.5Gb**HK$200 /10Gb

**HK$150 /6Gb

HK$30 /1Gb HK$28 /200MBHK$50 /1Gb

**HK$150 /10Gb

HK$28 /200MBHK$50 /1Gb

**HK$150 /10Gb

** Required to sign contracts

Source: HKT, HT, SMT, CMHK, DBS Vickers

Industry Focus


Page 3

Downside risk from handset business

The demand for iPhone 6S (launched in Sep 2015) in Hong Kong is much lower than that for iPhone 6 (launched in Sep 2014) due to relatively less newly added features and less trading demand from China. We expect downside risk for handset sales volume and margins, which should result in downward earnings revisions.

iPhone 6S was launched in Hong Kong and China on 25 Sep 2015. iPhone 6S is less popular than iPhone 6 because it has relatively less newly added features and the pent-up demand for a big screen was largely digested by the previous model. China also launched the product at the same time as Hong Kong and this eliminated the trading demand. We expect both the handset sales volume and margins to drop substantially.

We estimate that handset business contributed 29% and 24% to SMT’s 2H6/15 and HT’s 1H15 pre-tax profits respectively. We believe that SMT and HT will face downside risk from handset business. We accordingly revised down our earnings estimates for SMT by 1% in FY6/16F and for HT by 9% in FY15F.

Mobile sub movement analysis…

SMT has been gaining sub market share in the past few years, thanks to the launch of speed-capped plan which is a product targeting lower-spending customers. The company positioned the products clearly and well; and we do not see much cannibalisation or downgrade in its high-end market positioning. It becomes an additional revenue stream to SMT.

On the other hand, HT decided to give up lower-end subs to focus on mid-high-end customers. It has lost c.574k subs from 3,771k in FY13 to 3,197k in FY14 and further lost c.328k subs in 1H15 to 2,869k.

HKT/CSL started integrating the two mobile networks after the merger in May 2014. While this will bring cost synergy in the long term, it may result in short-term network instability. Re-branding exercise may also lead to some sub churn. We reckon that HKT lost mobile subs from 3,183k in 1H14 to 3,147k in 1H15.

Hong Kong mobile market share (2014)

HKT33%

HT23%

SMT14%

CMHK18%

Others12%

Source: HKT, HT, SMT, DBS Vickers

Industry Focus


Page 4

Broadband market

HKBN gaining market share amid heating up competition

Competition in the Hong Kong residential broadband market started to heat up earlier this year, and we believe it was initiated by HKBN. The company gained market share with 62k sub net-adds for FY8/15 (and 32k in 2HFY8/15) with 5% ARPU increase in the period. HKT’s sub base remained stable and it managed to increase the broadband revenue by 5% y-o-y in 1H15 through customer upgrades. The residential broadband revenues of HT and i-Cable, the two smaller players in residential broadband market, fell by 1% and 4% y-o-y respectively in 1H15 due to competition.

The market is concerned about an ongoing price war. HKBN earlier offered PCCW’s home telephone customers a special rate of “existing bill amount + HK$99”, for “VoIP voice service +100Mbps broadband service”. This offer was applicable exclusively to existing HKT customers who switched over their telephone numbers to HKBN. Meanwhile, HKT is also offering 6-12 months' free mobile broadband data usage to its selected residential broadband customers.

Despite the heating-up competition, HKBN gained 62k net-adds of residential broadband subs to a total of 754k in FY8/15 with ARPU improving to HK$183 from HK$175. We believe that HKBN will continue to focus on gaining market share going forward; and we expect more aggressive pricing strategies to come and a relatively stable ARPU in FY8/16.

HKT’s broadband revenue increased by 5% to c.HK$2,325m with a stable sub number in 1H15, despite market’s concerns on a potential price war in the residential segment. This is attributable to continuous customer upgrades to high-speed fibre service with higher tariff. We expect HKT to continue focusing on profitability rather than market share.

HT’s residential broadband revenue decreased by 1% y-o-y in 1H15 and remained a small contributor with only c.3% revenue contribution. HT started with the enterprise market in commercial areas, and then extended into the adjacent residential buildings based on commercial network coverage. Therefore, HT is not competing head-to-head with HKBN which focuses on densely populated residential areas.

i-Cable (1097 HK, NR) continued to report sub loss. The number of residential broadband subs fell by 7k to 179k in 1H15 from 186k in 2H14. We expect the downtrend to continue. The revenue of internet and multimedia fell by 4% y-

o-y from HK$180m in 1H14 to HK$174m in 1H15 due to broadband competition.

Hong Kong residential broadband market share (1H15)

HKT55%

HKBN29%

HT9%

i-Cable7%

Source: HKT, HKBN, HT, i-Cable, DBS Vickers

HKBN’s joint promotion with Letv

HKBN and Letv have a joint promotion to offer bundling package of fibre broadband services and multimedia content (including English Premier League [EPL]) provided by Letv. Win-win situations can be achieved as HKBN helps distribute Letv services while Letv (in particular the EPL broadcasting) attracts consumers to join HKBN’s broadband service through bundled package.

They are offering 12-month content services of Le TV Box 4K for free to new and retention customers of HKBN. They have also offered EPL plan with 100M broadband service plan at an average of HK$272 per month to 5,000 users on a first-come-first-served basis. NOW TV currently offers EPL plan (without broadband services) at HK$264 per month to new customers. NOW TV has lost its exclusive broadcasting rights for EPL in Hong Kong, and we believe that some customers will look for other options such as Letv. These will encourage those payTV as well as broadband users to switch to Letv and HKBN.

SMT more proactive on broadband business

SMT started offering fixed-line broadband services in 2014 with the network and services provided by HKBN. SMT has become more aggressive in the residential broadband market recently. SMT, to a certain extent, acts as a distributor of HKBN’s services. This allows the pure plays HKBN and SMT to have the capability of offering bundling services (mobile with broadband services) against integrated operators HKT and HT.

Industry Focus


Page 5

SMT is offering a residential broadband plan with a gimmick average monthly charge of HK$88.8 for a 100Mbps 30-month contract. But this actually includes a 6-month switch-in period (the overlapping period of the previous and the new contract). Excluding the switch-in period, the tariff is HK$111 per month. From HKBN’s perspective, the co-operation with SMT helps it to gain market share in some higher-end customers, despite a small cannibalisation to its existing sub base.

Earnings revisions

SMT. We have revised our earnings estimates down by 1% for FY6/16F to take into account the weaker handset sales, and revised up by 3% for FY6/17F on stronger mobile service revenue. We expect the pre-tax profit from handset sales, which accounted for c.34% of the total pretax profit in FY6/15, to drop by more than 50% in FY6/16F. We expect the drop to be partly offset by the 28% pretax profit improvement in mobile service segment driven by tariff hike and contribution from top-up plan in FY6/16F. As a result, we expect the earnings for FY6/16F to drop by 6% to Rmb875m due to weaker handset sales. In FY6/17F, we forecast the earnings to grow by 10% to HK$958m driven by ARPU increase for mobile service.

HKT. We have revised down our estimates for adjusted funds flow (AFF) per share stapled unit (SSU) by 4% for FY15F and 4% for FY16F respectively, to take into account slower mobile sub growth forecast, after a net-loss of 31k or 1% drop in

post-paid subs in 1H15. We therefore lowered our growth forecast for mobile service revenue. Downside risk from handset sales is limited to the company. We expect the AFF to grow by 17% to HK$3,919m in FY15F and 7% to HK$4,210m in FY16F attributable to the consolidation of CSL’s full-year results vs 7.5 months’ results in FY14 and cost synergy.

HT. We have revised down our earnings estimates by 9% for FY15F and 16% for FY16F, mainly due to lower handset sales estimate. We expect the pretax earnings from handset sales, which accounted for c.23% of the total pretax profit in FY14, to drop by more than 20% in FY15F. We also reckon that the negative impact from sub loss and shrinking roaming revenue will offset the improvement in ARPU and profitability, resulting in a flat mobile service earnings for FY16F. We expect the net profit to grow by 9% to HK$908m in FY15F due to cost savings but decrease by 4% to HK$875m in FY16F due to weaker handset sales.

HKBN. HKBN will focus on gaining market share in the near term and we expect more tactical pricing strategies to come. We expect a relatively stable ARPU in FY8/16. We forecast HKBN to achieve 10%/15%/20% five-year growth CAGRs for revenue/EBITDA/AFF supported by 300k sub net-adds with operating leverage in FY8/15-FY8/19F.

SmarTone and Hutchison Telecom pretax profit breakdowns

HK $m J un- 13 Dec - 13 J un- 14 Dec - 14 J un- 15

SmarT oneMobile Serv ice pretax profit 368 271 187 312 432

Handset pretax profit 92 41 38 252 135Hut ch ison T elec om

Mobile Serv ice pretax profit 593 296 414 481 545

Handset pretax profit 146 132 30 243 175

Source: SMT, HT, DBS Vickers

Industry Focus


Page 6

Valuation and recommendation

We like HKBN and SMT. They are smaller players with strong execution ability to drive market share expansion and business growth.

We are confident that HKBN will achieve its target of 300k broadband sub net-adds in FY8/15-FY8/19F, which will support 20%+ p.a. dividend growth in the coming few years. Maintain BUY on HKBN with an unchanged TP of HK$11.0 based on dividend discount model (DDM).

We have lowered our multiples for SMT and HT due to weaker earnings growth profile in the near term after taking the downside risk from handset sales into account.

SMT being a smaller player focusing on high-end subs, started to penetrate into specific lower-tier segment a few years back. It has successfully added a new revenue stream. It is also the

key beneficiary of mobile data tariff hike. Maintain BUY on SMT with TP of HK$15.0, pegged at 18x FY6/16F PE (lowered from previous 20x FY6/16F PE) which is in line with historical average.

Maintain HOLD on HT with TP of HK$2.7, pegged at 15x FY16F PE (lowered from previous 18x FY15F PE), which is in line with historical average. Maintain HOLD on HKT with a DDM-based TP of HK$9.1. We believe that both of the current share prices reflect their fair valuations.

Industry Focus


Page 7

Peers valuation

M kt PE PE Yie ld Yie ld P/B k P/B k EV/EB ITDA FCF Yie ld

Cu rre nc y Pr i c e Ca p Fi s c a l 15 F 1 6F 15 F 1 6F 1 5 F 1 6 F 15 F 16 F 1 5F 1 6 F

Co mp a n y Na me Cod e Loc a l$ US$ m Yr x x % % x x x x % %

Ho ng Kon g te le c o m op e ra to rs

HKT Trust* 6823 HK HKD 9.72 9,496 Dec 22.8 22.0 5.3 5.7 2.0 2.0 8.9 8.4 11.2 11.9

Hutchison Te lecom* 215 HK HKD 2.78 1,729 Dec 14.7 15.3 5.1 4.9 1.2 1.1 6.3 6.7 8.1 8.2

Smartone Te lecom* 315 HK HKD 11.74 1,606 Jun 13.2 14.1 5.1 5.3 3.2 3.0 4.0 4.6 17.8 17.6

HKBN* 1310 HK HKD 10.2 1,324 Aug 98.4 29.0 3.8 4.2 6.8 7.0 13.8 11.4 3.4 5.6

Ave ra g e 37 .3 20 .1 4 .8 5 .0 3 .3 3 .3 8 .2 7 .8 10 .1 1 0 .8

Ch in a te l e c o m o p e ra to rs

China Mobile* 941 HK HKD 88.8 234,598 Dec 12.1 11.8 3.6 3.6 1.6 1.5 3.9 3.8 2.3 3.2

China Unicom* 762 HK HKD 9.67 29,880 Dec 13.5 14.6 2.5 2.5 0.8 0.8 3.2 3.0 (11.1) 6.4

China Te lecom 'H'* 728 HK HKD 3.8 39,681 Dec 12.3 12.1 2.4 2.4 0.8 0.8 3.7 3.8 (3.7) (0.9)

Ave ra g e 12 .6 12 .9 2 .8 2 .8 1 .1 1 .0 3 .6 3 .5 (4 .1 ) 2 .9

Ta iwa n te le c om o pe ra to rs

Chunghwa Te lecom 2412 TT TWD 99 23,463 Dec 18.8 18.3 5.0 5.2 2.1 2.1 9.0 8.9 4.8 4.8

Taiwan Mobile 3045 TT TWD 100 10,451 Dec 18.0 17.4 5.4 5.5 4.9 4.8 10.6 10.2 6.5 6.8

Far Eastone Te lecom. 4904 TT TWD 69 6,869 Dec 19.0 17.8 5.4 5.6 3.1 3.1 9.2 8.7 6.6 7.3

Ave ra g e 18 .6 17 .9 5 .3 5 .4 3 .4 3 .4 9 .6 9 .2 6 .0 6 .3

Sing a p o re te le c o m op e ra to rs

Starhub* STH SP SGD 3.63 4,418 Dec 16.4 16.9 5.5 5.6 33.7 29.6 9.0 8.9 5.5 5.6

M1 M1 SP SGD 2.88 1,899 Dec 14.8 14.3 6.3 6.4 6.8 6.6 8.8 8.5 7.3 5.6

Ave ra g e 15 .7 15 .3 5 .5 5 .7 1 4 .3 1 2 .8 8 .9 8 .6 5 .6 5 .2

M a la ys ia te le c om o pe ra to rs

Axiata Group* AXIATA MK MYR 6.14 12,429 Dec 22.3 20.0 3.6 4.3 2.5 2.4 9.2 8.8 0.9 3.6

Digi.Com* DIGI MK MYR 5.12 9,302 Dec 21.5 20.3 4.7 4.9 58.0 58.0 12.9 12.4 4.4 4.7

Maxis* MAXIS MK MYR 6.55 11,295 Dec 24.2 22.6 4.1 4.3 10.4 10.2 13.2 12.8 4.5 4.9

Telekom Malaysia* T MK MYR 6.6 5,695 Dec 27.7 22.8 3.3 4.0 3.2 3.2 7.6 7.1 5.5 3.8

Ave ra g e 23 .9 21 .4 3 .9 4 .3 1 8 .5 1 8 .5 1 0 .7 10 .3 3 .8 4 .2

Source: Thomson Reuters, *DBS Vickers

Industry Focus


Page 8

PE & PB band charts

HKBN PE chart (1310 HK) HKBN PB chart (1310 HK)

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Industry Focus


Page 9

PE & PB band charts (contuine)

Hutchison Telecom PE chart (215 HK) Hutchison Telecom PB chart (215 HK)

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Smartone Telecom PE chart (315 HK) Smartone Telecom PB chart (315 HK)

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ASIAN INSIGHTS VICKERS SECURITIESwww.dbsvickers.com

ed-TH / sa- PY

BUY

Last Traded Price: HK$10.20 (HSI : 22,068) Price Target: HK$11.00 (8% upside) Potential Catalyst: Market share gain and ARPU increase Where we differ: We focus more on the long-term prospects despite short term growth volatility due to tactical pricing strategy Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected] Price Relative

Forecasts and Valuation FY Aug (HK$ m) 2014A 2015A 2016F 2017FTurnover 2,132 2,341 2,536 2,797 Core EBITDA 845 978 1,112 1,296 EBITDA 845 923 1,112 1,296 Pre-tax Profit 105 190 452 593 Net Profit 54 104 353 471 EPS (HK$) 0.05 0.10 0.35 0.47 EPS Gth (%) N/A 94.7 238.7 33.3 Diluted EPS (HK$) 0.05 0.10 0.35 0.47 AFCF 311 391 429 547 DPS (HK$) 0.00 0.20 0.43 0.54 BV Per Share (HK$) 1.63 1.51 1.66 1.70 PE (X) 191.6 98.4 29.0 21.8 P/Cash Flow (X) 11.7 14.0 10.5 9.0 P/Free CF (X) 19.4 29.0 17.8 14.8 EV/EBITDA (X) 15.2 14.0 11.4 9.7 Net Div Yield (%) 0.0 2.0 4.2 5.3 P/Book Value (X) 6.2 6.8 6.2 6.0 Net Debt/Equity (X) 1.6 1.8 1.5 1.4 ROAE (%) 3.3 6.6 22.2 27.9 Earnings Rev (%): Nil Nil Nil Consensus EPS (HK$) 0.28 0.40 0.50 Other Broker Recs: B: 8 S: 0 H: 2

Source of all data: Company, DBSV, Thomson Reuters, HKEX

TACTICAL PRICING STRATEGY TO DRIVE DIVIDEND GROWTH Buying opportunity emerges due to excessive concerns on price war Market’s excessive concerns on price war in the Hong Kong residential broadband market offer a buying opportunity on HKBN. The company has been successful in gaining market share through its aggressive and effective pricing strategy. We estimate that the recent price discount for new subscribers would have limited impact on its core EBITDA, but could help achieve long-term growth. Market share gain through tactical pricing strategy HKBN increased its market share from c.16% in FY8/08 to c.29% in FY8/15, and is now the second largest residential broadband operator in Hong Kong. It strategically offers deep discounts to lure subs away from competitors from time to time. Upon contract renewal, it raises the tariff back to normal level which is still lower than that of its major competitor HKT (6823 HK). Churn rate has been maintained at a low level. The incumbent operator HKT focuses on stable profitability and cash flow, and therefore has less flexibility to undercut HKBN’s pricing. A growth stock with decent dividend yield We expect the company to grow its revenue by 10% p.a. from FY8/16-FY8/19F, driven by market share gain and ARPU improvement. In view of the recent marketing campaign, we estimate that its core EBITDA will grow slower at 14% for FY8/16F, but accelerate to 16% for FY8/17F upon contract renewal. The company intends to pay out 90-100% adjusted free cash flow (AFCF), which is estimated to grow at 20% p.a. from FY8/16-FY8/19F. The stock offers a 4.3% dividend yield for FY8/16F and 5.5% for FY8/17F. Valuation:

Decent dividend yield with strong growth opportunity. We derive our TP of HK$11.0 based on dividend discount model (DDM), with 7.9% cost of equity and 1% terminal growth rate. Key Risks to Our View:

A real price war. Competitors irrationally cut prices to be lower than that offered by HKBN for a prolonged period of time.

Increase in finance cost in interest rate up-cycle. Increase in interest rates will decrease the adjusted free cash flow and the dividend yield.

At A Glance Issued Capital (m shrs) 1,006 Mkt. Cap (HK$m/US$m) 10,258 / 1,324

Major Shareholders Canada Pension Plan Investment Board (%) 18.0 GIC Private Limited (%) 9.0 The Capital Group Companies, Inc. (%) 6.0 Mondrian Investment Partners Limited (%) 5.6 JP Morgan Asset Management (%) 5.1

Free Float (%) 100.0 3m Avg. Daily Val. (US$m) 3.6 ICB Industry : Telecommunications / Mobile Telecommunications

73

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10.8

Mar-15 Jun-15 Sep-15

Relative IndexHK$

HKBN Ltd. (LHS) Relative HSI INDEX (RHS)


China / Hong Kong Company Guide

HKBN Ltd. Edition 1 Version 1 |Bloomberg: 1310 HK Equity | Reuters: 1310.HK

Refer to important disclosures at the end of this report

ASIAN INSIGHTS VICKERS SECURITIES

Page 2

Company Guide

HKBN Ltd.

CRITICAL DATA POINTS TO WATCH

Earnings Drivers:

Expanding market share through tactical pricing strategy. HKBN has been gaining market share from its competitors through its aggressive pricing strategy. It strategically offers deep discounts to gain new subscribers, and has been capable of raising back the tariff upon contract renewal. It has a track record of managing ARPU growth over a longer period of time despite short-term volatility. We are confident that HKBN can achieve its target of 300k net-adds in five years through a similar strategy.

Rising ARPU. We forecast HKBN’s ARPU to grow by c.4% p.a. through (i) upselling higher-tier plan, and (ii) narrowing the price differences with HKT in selected estates. As a percentage of subscriber number, HKBN’s subscribers for 500Mbps and 1,000Mbps increased from 8% in FY8/12 to 16% in FY8/14. We expect HKBN to continue upselling higher-tier plans to its customers. HKT generally charges a c.20% premium over HKBN’s pricing. HKBN may selectively narrow the differences in some areas without losing its customers. Migration to fibre. Consumers are looking for faster broadband connection due to rising demand for internet multimedia content, and therefore continuously migrate to fibre network (FTTx), from other slower technologies such as Hybrid Fibre Coaxial (HFC) and Digital Subscriber Line (xDSL) for broadband services. HKBN’s Metro Ethernet network supports symmetric upstream/downstream transmission speeds from 100Mbps to 1,000Mbps, while HFC and xDSL offer only up to a maximum of 100Mbps downstream speed with limitations such as lower upstream speeds. We expect HKBN to gain market share from operators providing HFC and xDSL network services. Replication of success in residential market to enterprise market. HKBN is replicating its success in the residential broadband market to the enterprise market. HKBN focuses on the small enterprise segment, of which broadband penetration is expected to increase due to the robust development of cloud services, enterprise internet applications and e-commerce. We expect the revenue from HKBN's enterprise broadband business to grow at a 11% CAGR from FY8/16-FY8/17F.

broadband sub (k)

ARPU (HK$)

Core EBITDA (HK$m)

AFCF (HK$m)

Source: Company, DBS Vickers

660692

754

834894

0

100

200

300

400

500

600

700

800

900

2013A 2014A 2015A 2016F 2017F

158

175183 183 184

0

38

75

113

150

188

2013A 2014A 2015A 2016F 2017F

0%

5%

10%

15%

20%

0200400600800

1,0001,2001,400

FY13 FY14 FY15 FY16F FY17F

Core EBITDA Growth %

0%5%10%15%20%25%30%35%40%

0

100

200

300

400

500

600

FY13 FY14 FY15 FY16F FY17F

AFCF Growth %


Page 3

Company Guide

HKBN Ltd.

Balance Sheet:

Strong free cash flow. The company generates strong free cash flow with expected growth rate of 20% p.a. The company intends to pay out 90-100% of the adjusted free cash flow (AFCF) as dividend. AFCF is derived from core EBITDA adjusted for capex, net interest, non-recurring items, non-cash items, tax paid and changes in working capital. Healthy balance sheet. HKBN had a total borrowing of HK$3bn in FY8/15 and it intends to maintain the current debt level. Debt-to-EBITDA ratio stood at a healthy level of 3.1x in FY8/15. Share Price Drivers:

Stronger sub growth. Management is targeting 300k net-adds (or 60k p.a. on average) in FY8/15-FY8/19F. Faster sub net-adds will be positive for share price.

Increase in ARPU. HKBN has a track record of managing ARPU growth over a longer period of time despite aggressive pricing strategy and short term volatility. While market is concerned about ARPU pressure due to price discounts, we expect an uptrend in ARPU driven by upselling of bandwidth and the narrowing of the price differences with HKT in selected estates in the medium term. Stronger dividend growth. Strong business growth and operating leverage could lead to stronger EBITDA growth. Reduction in capex as a percentage of revenue will further enhance the AFCF and therefore dividend distribution

Key Risks:

A real price war Competitors irrationally cut prices to be lower than that offered by HKBN for a prolonged period of time. Increase in interest rates Increase in interest rates will decrease the adjusted free cash flow and the dividend yield.

Company Background:

HKBN is a broadband service provider in Hong Kong. It is the second largest player in the residential segment with a market share of c.29%.

Leverage & Asset Turnover (x)

Capital Expenditure (HK$m)

ROE (%)

Forward EV/EBITDA (x)

PB Band (x)


0.3

0.3

0.3

0.4

0.4

0.4

0.4

0.4

0.5

0.5

0.5

0.00

0.50

1.00

1.50

2.00

2013A 2014A 2015A 2016F 2017F

Gross Debt to Equity (LHS) Asset Turnover (RHS)

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

450.0

500.0

2013A 2014A 2015A 2016F 2017F

Capital Expenditure (-)

HK$

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2013A 2014A 2015A 2016F 2017F

8.0 8.5 9.0 9.5

10.0 10.5 11.0 11.5 12.0 12.5

Mar

-15

May

-15

Jul-1

5

Sep-

15

x

Avg: 10.7x

+1SD: 11.7x

-1SD: 9.8x

Avg: 5.97x

+1sd: 6.38x

+2sd: 6.8x

‐1sd: 5.56x

‐2sd: 5.14x

4.5

5.0

5.5

6.0

6.5

7.0

7.5

Mar-15 Jun-15 Sep-15

(x)


Page 4

Company Guide

HKBN Ltd.

Key Assumptions

FY Aug 2013A 2014A 2015A 2016F 2017F broadband sub (k) 660 692 752 812 872 ARPU (HK$) 158 175 186 189 198

Income Statement (HK$ m) FY Aug 2013A 2014A 2015A 2016F 2017F Revenue 1,949 2,132 2,341 2,536 2,797 Cost of Goods Sold (305) (287) (306) (304) (308)

Gross Profit 1,644 1,844 2,035 2,232 2,489

Other Opng (Exp)/Inc (1,454) (1,552) (1,588) (1,633) (1,750)

Operating Profit 191 293 447 599 739

Other Non Opg (Exp)/Inc 0 0 0 0 0

Associates & JV Inc 0 0 0 0 0

Net Interest (Exp)/Inc (301) (188) (257) (147) (147)

Dividend Income 0 0 0 0 0

Exceptional Gain/(Loss) 0 0 0 0 0

Pre-tax Profit (110) 105 190 452 593

Tax (29) (51) (86) (99) (122)

Minority Interest 0 0 0 0 0

Preference Dividend 0 0 0 0 0

Net Profit (139) 54 104 353 471

Net Profit before Except. (139) 54 104 353 471

EBITDA 741 845 923 1,112 1,296

Growth

Revenue Gth (%) (2.3) 9.3 9.8 8.3 10.3

EBITDA Gth (%) 12.4 14.1 9.2 20.5 16.5

Opg Profit Gth (%) (45.0) 53.6 52.7 33.8 23.5

Net Profit Gth (%) N/A N/A 94.7 238.7 33.3

Margins & Ratio

Gross Margins (%) 84.3 86.5 86.9 88.0 89.0

Opg Profit Margin (%) 9.8 13.7 19.1 23.6 26.4

Net Profit Margin (%) (7.1) 2.5 4.5 13.9 16.8

ROAE (%) (6.8) 3.3 6.6 22.2 27.9

ROA (%) (2.4) 0.9 1.9 6.3 8.3

ROCE (%) 3.5 2.8 4.8 9.1 11.3 Div Payout Ratio (%) N/A 0.0 192.9 121.5 116.2 Net Interest Cover (x) 0.6 1.6 1.7 4.1 5.0 Source: Company, DBS Vickers


Page 5

Company Guide

HKBN Ltd.

Balance Sheet (HK$ m)

FY Aug 2013A 2014A 2015A 2016F 2017F Net Fixed Assets 1,943 1,957 1,970 1,972 1,973 Invts in Associates & JVs 0 0 0 0 0 Other LT Assets 3,270 3,044 2,954 2,844 2,734 Cash & ST Invts 355 436 329 557 675 Inventory 14 22 14 15 16 Debtors 75 80 82 86 90 Other Current Assets 199 181 202 212 223

Total Assets 5,855 5,719 5,551 5,686 5,711 ST Debt

0 0 0 0 0 Creditors 14 12 7 7 7 Other Current Liab 443 541 482 489 495 LT Debt 3,231 2,994 3,019 3,019 3,019 Other LT Liabilities 578 530 529 506 482 Shareholder’s Equity 1,590 1,643 1,514 1,666 1,708 Minority Interests 0 0 0 0 0 Total Cap. & Liab. 5,855 5,719 5,551 5,686 5,711 Non-Cash Wkg. Capital (170) (270) (190) (182) (174) Net Cash/(Debt) (2,876) (2,558) (2,690) (2,462) (2,344) Debtors Turn (avg days) 12.9 13.3 12.6 12.1 11.5 Creditors Turn (avg days) (33.1) (18.0) (19.5) (11.7) (10.4) Inventory Turn (avg days) (33.3) (24.3) (38.8) (25.7) (22.7) Asset Turnover (x) 0.3 0.4 0.4 0.5 0.5 Current Ratio (x) 1.4 1.3 1.3 1.8 2.0 Quick Ratio (x) 0.9 0.9 0.8 1.3 1.5 Net Debt/Equity (X) 1.8 1.6 1.8 1.5 1.4 Net Debt/Equity ex MI (X) 1.8 1.6 1.8 1.5 1.4 Capex to Debt (%) 10.0 11.5 12.6 13.4 14.8 Z-Score (X) NA NA NA NA NA Source: Company, DBS Vickers

Cash Flow Statement (HK$ m)

FY Aug 2013A 2014A 2015A 2016F 2017F Pre-Tax Profit (110) 105 190 452 593 Dep. & Amort. 550 552 476 514 556 Tax Paid (4) (43) (86) (114) (137) Assoc. & JV Inc/(loss) 0 0 0 0 0 (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. 22 74 (99) (8) (9) Other Operating CF 307 186 252 138 138

Net Operating CF 765 875 733 982 1,141 Capital Exp.(net) (324) (346) (380) (406) (448) Other Invts.(net) 0 0 0 0 0 Invts in Assoc. & JV 0 0 0 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF (64) 22 8 4 4 Net Investing CF (389) (324) (372) (401) (443) Div Paid (776) 0 (431) (201) (429) Chg in Gross Debt 715 (256) 25 0 0 Capital Issues 0 0 198 0 0 Other Financing CF (147) (169) (260) (151) (151) Net Financing CF (208) (425) (468) (352) (580) Currency Adjustments 2 0 0 0 0 Chg in Cash 171 126 (107) 228 118 Opg CFPS (HK$) 0.74 0.80 0.83 0.98 1.14 Free CFPS (HK$) 0.44 0.53 0.35 0.57 0.69 Source: Company, DBS Vickers


Page 6

Company Guide

HKBN Ltd.

Target Price & Ratings History

Source: DBS Vickers

1 2

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep-

15

Oct

-15

No

v-1

5

HK$S.No. Da te Clos ing Ta rge t Ra ting

Pric e Pric e1: 26-Oct-15 HK$8.98 HK$ 11.00 Buy2: 3-Nov-15 HK$9.18 HK$11.00 Buy


ed-TH/ sa- PY

HOLD Last Traded Price: HK$9.72 (HSI : 22,068) Price Target: HK$9.10 (-6% downside) (Prev HK$9.50) Potential Catalyst: Price hike and market share gain Where we differ: We believe HKT focuses on profitability and stable AFF rather than market share, making it unlikely to cut prices Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected] Price Relative

Forecasts and Valuation FY Dec (HK$ m) 2014A 2015F 2016F 2017FTurnover 28,823 32,419 34,028 35,044 EBITDA 10,310 12,052 12,722 13,037 Pre-tax Profit 3,300 3,815 3,940 4,031 Net Profit 2,991 3,225 3,349 3,427 Net Pft (Pre Ex) 2,991 3,225 3,349 3,427 EPS (HK$) 0.42 0.43 0.44 0.45 AFF 3.354 3.919 4.210 4.308 AFF / SSU 0.44 0.52 0.56 0.57 EPS Gth (%) 10.0 0.9 3.8 2.3 Diluted EPS (HK$) 0.42 0.43 0.44 0.45 DPS (HK$) 0.47 0.52 0.56 0.57 BV Per Share (HK$) 5.35 4.94 4.85 4.74 PE (X) 23.0 22.8 22.0 21.5 P/Cash Flow (X) 7.2 6.5 6.2 6.0 P/Free CF (X) 9.8 8.9 8.4 8.3 EV/EBITDA (X) 9.9 8.8 8.4 8.1 Net Div Yield (%) 4.9 5.3 5.7 5.9 P/Book Value (X) 1.8 2.0 2.0 2.1 Net Debt/Equity (X) 0.9 0.9 0.9 0.9 ROAE (%) 8.7 8.6 9.0 9.4 Earnings Rev (%): (6.0) (5.4) New Consensus EPS (HK$) 0.51 0.56 0.60 Other Broker Recs: B: 9 S: 0 H: 5


Incumbent operator with stable yield Stable dividend yield. We have a HOLD rating on HKT, with a DDM-based TP of HK$9.1. We believe that the current valuation reflects its fair value. HKT offers a stable dividend yield of c.5.3%. It is an incumbent player in the fixed-line segment with residential market share threatened by HKBN. It became the largest mobile operator after merging with CSL in FY14. HKT intends to pay out 100% of adjusted fund flows which is expected to grow at single-digit rate p.a. Growth driven by CSL consolidation plus cost synergy. HKT benefits from the disciplined price competition environment in the mobile market through ARPU increase. We also expect more cost synergies from the merger with CSL to materialise in the future. On the other hand, HKT faces aggressive pricing strategy from HKBN in the residential broadband market. Despite market’s concern on price war, broadband network revenue increased by 5% in 1H15, driven by customer upgrades. We expect the overall fixed-line business to be stable with a low-single-digit growth. Limited upside on share price. We forecast AFF, which is fully distributed as dividends, to grow at 17% in FY15F and 7.4% FY16F, driven by the consolidation of CSL’s full-year results in FY15 and the cost synergy from the merger. We reckon a steady AFF growth at a single-digit rate after FY16F. With limited growth potential, we believe its current valuation offers limited upside on share price. Valuation:

We have a HOLD rating on HKT, with a DDM-based TP of HK$9.1 (with 7.6% cost of equity and 1% terminal growth rate). We believe that the current share price has largely reflected its fair value. Key Risks to Our View:

Availability of “star” handsets (upside risk). Mobile operators would have stronger pricing power to raise the tariffs for handset-bundled mobile data plans during the launch of “star” handsets. Interest rate up-cycle (downside risk). Increase in interest rates will reduce the adjusted funds flow and therefore the dividend distribution.


Major Shareholders PCCW Limited (%) 63.1 The Capital Group Companies, Inc. (%) 6.9

Free Float (%) 36.9 3m Avg. Daily Val. (US$m) 7.1 ICB Industry : Telecommunications / Fixed Line

l i i

84

104

124

144

164

184

204

3.9

4.9

5.9

6.9

7.9

8.9

9.9

10.9

11.9

Nov-11 Nov-12 Nov-13 Nov-14

Relative IndexHK$

HKT Trust (LHS) Relative HSI INDEX (RHS)



HKT Trust Edition 1 Version 1 |Bloomberg: 6823 HK Equity | Reuters: 6823.HK



Page 2

Company Guide

HKT Trust


Earnings Drivers:

CSL consolidation plus cost savings. HKT has been integrating CSL’s networks as well as optimising the retail channels. We expect cost savings as well as other synergies in operation after the HKT/CSL integration. It targets to close down 380 cell sites (or 1/3 of total) in FY15F and we expect more closures in the future. This should have saved network maintenance costs, which is positive to earnings and operating cash flow. Mobile tariff hike. The competitive environment in the Hong Kong mobile market has improved since the merger of HKT and CSL. Operators have been able to raise the tariffs for mobile data plans in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. HKT has now become the largest mobile operator. It is well positioned to take the lead to raise the tariff when the timing is appropriate. Mobile sub growth. Hong Kong's mobile market is matured with low-single-digit growth in the past two years. It is dominated by HKT, Hutchison Telecom, SmarTone and China Mobile Hong Kong with market shares c.33%, c.20%, c.14% and c.20% respectively in 2014. We expect HKT to continue optimising its customer mix to align its new rebranding (csl., 1O1O and SUN mobile). We believe that HKT will continue to grow its mobile sub base going forward.

Mobile sub growth (%)

Mobile ARPU (HK$)

EBITDA margin (%)


1

177

1 1 10

36

72

108

145

181

2013A 2014A 2015F 2016F 2017F

133

222

168181 186

0

28

56

84

112

140

168

196

225

2013A 2014A 2015F 2016F 2017F

34.6 35.537.3 37.5 37.3

0.0

7.6

15.1

22.7

30.3

2013A 2014A 2015F 2016F 2017F


Page 3

Company Guide

HKT Trust

Balance Sheet:

Healthy financials with a debt-to-EBITDA ratio of 3.6x. HKT had bank borrowings of HK$36bn and the debt to EBITDA ratio remained healthy at 3.6x in FY14. Average debt maturity is around five years with effective interest rate of c.2.9%. The company intends to pay out 100% adjusted funds flow (which is basically free cash flow), and maintains debt level unchanged. Share Price Drivers:

CSL consolidation plus cost savings. HKT has been integrating CSL’s networks as well as optimising the retail channels. We expect cost savings as well as other synergies in operation after the HKT/CSL integration. It targets to close down 380 cell sites (or 1/3 of total) in FY15F and we expect more closures in the future. Tariff hike in the mobile market. We believe the price competition in the industry is disciplined as mobile operators focus more on profitability rather than market share. We believe further tariff hikes will focus on the lower-tier plans to narrow the gap between lower-tier and high-tier plans to prevent trade downs. Mobile sub growth. HKT rebranded SUM Mobile to focus on mass market and csl. and 1O1O to focus on mid- to high-end postpaid customers. The brands have clear market focuses and price differentials. We believe this market repositioning may lead to some marginal postpaid sub loss in the near term but the impact should be limited. Signs of bottoming out are positive to the share price.

Key Risks:

Market competition. HKT faces severe competition from HKBN in the residential broadband market. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Interest rate up-cycle. Increase in interest rates will reduce the adjusted fund flows and therefore the dividend distribution.

COMPANY BACKGROUND

HKT is an integrated telecom services provider in Hong Kong, with the largest market share in the fixed-line and mobile market. The broadband services are provided via the brand “Netvigator” and the mobile services are provided via the brands “SUN Mobile”, “csl.” and “1O1O”. HKT is 63.07% owned by PCCW.



ROE (%)

Forward PE Band

PB Band


0.3

0.3

0.3

0.3

0.3

0.4

0.4

0.4

0.4

0.4

0.4

0.00

0.20

0.40

0.60

0.80

1.00

2013A 2014A 2015F 2016F 2017F


0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

2013A 2014A 2015F 2016F 2017F


HK$

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

2013A 2014A 2015F 2016F 2017F

Avg: 19.8x

+1sd: 22x

+2sd: 24.1x

‐1sd: 17.6x

‐2sd: 15.5x

12.9

14.9

16.9

18.9

20.9

22.9

24.9

26.9


(x)

Avg: 1.51x

+1sd: 1.86x

+2sd: 2.22x

‐1sd: 1.15x

‐2sd: 0.8x

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5


(x)


Page 4

Company Guide

HKT Trust

Key Assumptions

FY Dec 2013A 2014A 2015F 2016F 2017F Fixed-line sub growth (%)

0.2 0.1 0.2 0.2 0.2

Broadband sub growth (%)

0.0 0.0 0.5 0.3 0.2

Mobile sub growth (%) 0.5 177.2 1.5 0.9 1.0 Mobile ARPU 132.7 222.3 168.1 181.1 186.5 EBITDA margin (%) 34.6 35.5 37.3 37.5 37.3

Segmental Breakdown (HK$ m)

FY Dec 2013A 2014A 2015F 2016F 2017F Revenues (HK$ m) TSS 19,251 19,913 20,493 21,046 21,556 Mobile 3,371 8,950 12,088 13,176 13,703 Other businesses 688 564 500 500 500 Elliminations (478) (604) (662) (694) (715) Total 22,832 28,823 32,419 34,028 35,044 Source: Company, DBS Vickers

Income Statement (HK$ m) FY Dec 2013A 2014A 2015F 2016F 2017F Revenue 22,832 28,823 32,419 34,028 35,044 Cost of Goods Sold (10,117) (12,053) (13,357) (14,087) (14,578)

Gross Profit 12,715 16,770 19,062 19,940 20,466

Other Opng (Exp)/Inc (9,501) (12,416) (13,875) (14,564) (14,999)

Operating Profit 3,214 4,354 5,187 5,376 5,467

Other Non Opg (Exp)/Inc 84 99 0 0 0

Associates & JV Inc 50 (29) (29) (29) (29)

Net Interest (Exp)/Inc (833) (1,124) (1,343) (1,407) (1,407)

Dividend Income 0 0 0 0 0

Exceptional Gain/(Loss) 0 0 0 0 0

Pre-tax Profit 2,515 3,300 3,815 3,940 4,031

Tax (16) (242) (550) (552) (564)

Minority Interest (39) (67) (40) (40) (40)

Preference Dividend 0 0 0 0 0

Net Profit 2,460 2,991 3,225 3,349 3,427

Net Profit before Except. 2,460 2,991 3,225 3,349 3,427

EBITDA 8,048 10,310 12,052 12,722 13,037

Growth

Revenue Gth (%) 8.3 26.2 12.5 5.0 3.0

EBITDA Gth (%) 5.8 28.1 16.9 5.6 2.5

Opg Profit Gth (%) 7.8 35.5 19.1 3.7 1.7

Net Profit Gth (%) 52.8 21.6 7.8 3.8 2.3

Margins & Ratio

Gross Margins (%) 55.7 58.2 58.8 58.6 58.4

Opg Profit Margin (%) 14.1 15.1 16.0 15.8 15.6

Net Profit Margin (%) 10.8 10.4 9.9 9.8 9.8

ROAE (%) 8.0 8.7 8.6 9.0 9.4

ROA (%) 3.7 3.8 3.6 3.8 3.9

ROCE (%) 5.4 5.9 5.6 5.9 6.0 Div Payout Ratio (%) 117.9 112.1 121.5 125.7 125.7 Net Interest Cover (x) 3.9 3.9 3.9 3.8 3.9 Source: Company, DBS Vickers


Page 5

Company Guide

HKT Trust

Interim Income Statement (HK$ m)

FY Dec 1H2013 2H2013 1H2014 2H2014 1H2015 Revenue 11,071 11,761 12,520 16,303 15,974 Cost of Goods Sold (4,901) (5,216) (5,333) (6,720) (6,544) Gross Profit 6,170 6,545 7,187 9,583 9,430 Other Oper. (Exp)/Inc (4,720) (4,781) (5,114) (7,302) (6,851) Operating Profit 1,450 1,764 2,073 2,281 2,579 Other Non Opg (Exp)/Inc 49 35 41 58 33

Associates & JV Inc 6 44 2 (31) (15)

Net Interest (Exp)/Inc (458) (375) (452) (672) (631) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 1,047 1,468 1,664 1,636 1,966 Tax 161 (177) (245) 3 (171) Minority Interest (19) (20) (19) (48) (17) Net Profit 1,189 1,271 1,400 1,591 1,778 Net profit bef Except. 1,189 1,271 1,400 1,591 1,778 Growth Revenue Gth (%) 14.0 3.5 13.1 38.6 27.6 Opg Profit Gth (%) (0.5) 15.7 43.0 29.3 24.4 Net Profit Gth (%) 52.8 52.8 17.7 25.2 27.0 Margins Gross Margins (%) 55.7 55.7 57.4 58.8 59.0 Opg Profit Margins (%) 13.1 15.0 16.6 14.0 16.1 Net Profit Margins (%) 10.7 10.8 11.2 9.8 11.1 Source: Company, DBS Vickers


Page 6

Company Guide

HKT Trust


FY Dec 2013A 2014A 2015F 2016F 2017F Net Fixed Assets 14,399 15,767 15,916 16,073 16,235 Invts in Associates & JVs 852 721 692 663 634 Other LT Assets 41,097 61,054 60,008 58,772 57,494 Cash & ST Invts 2,134 3,613 3,809 3,954 4,003 Inventory 1,018 621 652 685 719 Debtors 3,000 3,875 4,069 4,272 4,486 Other Current Assets 3,319 4,149 4,349 4,560 4,780


0 3,877 3,877 3,877 3,877 Creditors 1,803 1,979 2,078 2,182 2,291 Other Current Liab 5,354 8,559 8,559 8,559 8,559 LT Debt 24,022 32,549 32,549 32,549 32,549 Other LT Liabilities 3,835 4,797 4,852 4,907 4,964 Shareholder’s Equity 30,623 37,932 37,433 36,717 35,885 Minority Interests 182 107 147 187 227 Total Cap. & Liab. 65,819 89,800 89,495 88,978 88,352 Non-Cash Wkg. Capital 180 (1,893) (1,567) (1,224) (865) Net Cash/(Debt) (21,888) (32,813) (32,617) (32,472) (32,423) Debtors Turn (avg days) 51.4 43.5 44.7 44.7 45.6 Creditors Turn (avg days) 127.0 111.9 114.6 115.8 117.0 Inventory Turn (avg days) 67.0 48.5 36.0 36.3 36.7 Asset Turnover (x) 0.3 0.4 0.4 0.4 0.4 Current Ratio (x) 1.3 0.9 0.9 0.9 0.9 Quick Ratio (x) 0.7 0.5 0.5 0.6 0.6 Net Debt/Equity (X) 0.7 0.9 0.9 0.9 0.9 Net Debt/Equity ex MI (X) 0.7 0.9 0.9 0.9 0.9 Capex to Debt (%) 8.2 6.9 8.5 8.9 9.1 Z-Score (X) 2.2 1.7 1.8 1.9 1.9 Source: Company, DBS Vickers


Page 7

Company Guide

HKT Trust


FY Dec 2013A 2014A 2015F 2016F 2017F Pre-Tax Profit 2,515 3,300 3,815 3,940 4,031 Dep. & Amort. 4,700 5,886 6,894 7,374 7,599 Tax Paid (331) (395) (495) (496) (508) Assoc. & JV Inc/(loss) (50) 29 29 29 29 (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. (518) (545) (326) (342) (360) Other Operating CF 827 1,294 1,393 1,457 1,457

Net Operating CF 7,143 9,569 11,310 11,962 12,248 Capital Exp.(net) (1,980) (2,510) (3,080) (3,233) (3,329) Other Invts.(net) (2,091) (3,219) (2,918) (3,062) (3,154) Invts in Assoc. & JV 0 0 0 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF (152) (18,857) 0 0 0 Net Investing CF (4,223) (24,586) (5,997) (6,295) (6,483) Div Paid (2,731) (3,141) (3,724) (4,064) (4,259) Chg in Gross Debt 298 11,909 0 0 0 Capital Issues 0 7,807 0 0 0 Other Financing CF (751) (34) (1,393) (1,457) (1,457) Net Financing CF (3,184) 16,541 (5,117) (5,521) (5,716) Currency Adjustments (3) (45) 0 0 0 Chg in Cash (267) 1,479 196 145 49 Opg CFPS (HK$) 1.19 1.43 1.54 1.63 1.67 Free CFPS (HK$) 0.80 1.00 1.09 1.15 1.18 Source: Company, DBS Vickers


Source: DBS Vickers

1 23 4

8.0

8.5

9.0

9.5

10.0

10.5

11.0

No

v-1

4

Dec

-14

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5


Pric e Pric e1: 30-Jan-15 HK$9.91 HK$9.20 Hold2: 11-Feb-15 HK$10.14 HK$9.70 Hold3: 27-Jul-15 HK$9.52 HK$9.50 Hold4: 6-Aug-15 HK$9.11 HK$9.50 Hold


ed-TH/ sa- PY

HOLD Last Traded Price: HK$2.79 (HSI : 22,489) Price Target: HK$2.70 (-3% downside) (Prev HK$3.70) Potential Catalyst: Price hike and availability of “star” handsets Where we differ: Our earnings estimates for FY15-16F are lower than concensus Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected] Price Relative

Forecasts and Valuation FY Dec (HK$ m) 2014A 2015F 2016F 2017FTurnover 16,296 18,145 16,160 16,519 EBITDA 2,644 2,731 2,772 2,891 Pre-tax Profit 1,168 1,266 1,226 1,265 Net Profit 833 908 875 908 Net Pft (Pre Ex) 833 908 875 908 EPS (HK$) 0.17 0.19 0.18 0.19 EPS Gth (%) (9.1) 9.1 (3.7) 3.7 Diluted EPS (HK$) 0.17 0.19 0.18 0.19 DPS (HK$) 0.13 0.14 0.14 0.14 BV Per Share (HK$) 2.34 2.40 2.44 2.49 PE (X) 16.1 14.8 15.4 14.8 P/Cash Flow (X) 5.4 5.4 5.4 5.2 P/Free CF (X) 10.2 12.3 12.3 11.4 EV/EBITDA (X) 6.6 6.3 6.7 6.3 Net Div Yield (%) 4.6 5.1 4.9 5.1 P/Book Value (X) 1.2 1.2 1.1 1.1 Net Debt/Equity (X) 0.3 0.3 0.4 0.3 ROAE (%) 7.5 8.0 7.5 7.6 Earnings Rev (%): (8.6) (15.8) New Consensus EPS (HK$) 0.20 0.21 0.21 Other Broker Recs: B: 3 S: 0 H: 8


REPOSITIONING TO MID-HIGH END MARKET Current valuation reflects fair value. We have a HOLD rating on Hutchison Telecom (HT) as we believe the current valuation has reflected its fair value. HT has been losing subs since the decision to give up the lower-end market in FY14. The profitability improved due to cost savings. The company benefits from the disciplined price competition environment in the mobile market but also faces the downside risk from handset sales. Mobile ARPU increase offset by mobile sub loss and declining roaming revenue. HT has taken multiple initiatives to improve the Mobile ARPU. It raised tariff of its 4G SIM-only plans by HK$20-30 to narrow the pricing discounts to its major competitors SmarTone (SMT, 315 HK, BUY) and HKT (6823 HK, HOLD). It also launched “Top Up Data Pack” with additional HK$40 per month for 1Gb or HK$70 per month for 2.5Gb to enhance ARPU. However, we reckon that the mobile ARPU improvement will be offset by the mobile sub loss and declining roaming revenue. Expect stable service revenue with declining handset sales profit. Demand for iPhone 6S in HK is lower than that for iPhone 6. We expect the earnings in FY15F to grow by 9% to HK$908m, due to 17% earnings improvement from service which is partly offset by 20% drop in earnings from handset sales. In FY16F, we expect the handset sales profit to drop by a further 20% and the contribution from mobile service to be stable. We forecast the net profit for FY16F to fall by 4% to HK$875m. Valuation: We have a HOLD rating on HT. Our target price of HK$2.7 is pegged at 15x FY16F PE, which is in line with the historical average. Key Risks to Our View:

Availability of “star” handsets (upside risk). Launch of “star” handsets could result in higher handset sales volume and margins. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans. Irrational market competition (downside risk). Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war.


Major Shareholders CK Hutchison Holdings Ltd. (%) 66.1 The Capital Group Companies, Inc. (%) 5.1 0 (%) 0.0


61

81

101

121

141

161

181

201

221

2.3

2.8

3.3

3.8

4.3

4.8

Nov-11 Nov-12 Nov-13 Nov-14 Nov-15

Relative IndexHK$

Hutchison Telecom (LHS) Relative HSI INDEX (RHS)



Hutchison Telecom Edition 1 Version 1 | Bloomberg: 215 HK Equity | Reuters: 0215.HK Refer to important disclosures at the end of this report


Page 2

Company Guide

Hutchison Telecom


Earnings Drivers:

Tariff hike. The competition environment has improved since the merger of HKT and CSL. Operators have been able to raise the tariffs for mobile data plans in the past 1-2 years. The market recently focuses more on raising the tariffs for lower-tier plans and launching various top-op plans to monetise more data usage. HT has also taken multiple initiatives to increase the mobile ARPU. It has raised the tariffs of its 4G SIM-only plans by HK$20-30 to narrow the pricing discounts to its major competitors. It also launched “Top Up Data Pack” with additional HK$40 per month for 1Gb or HK$70 per month for 2.5Gb to enhance mobile ARPU. Mobile ARPU uplift will be a key earnings growth driver. Mobile sub growth. Hong Kong mobile market is more or less matured with low-single-digit sub growth in the past two years. There are four major players: HKT, Hutchison Telecom, SmarTone and China Mobile Hong Kong with market shares of c.33%, c.20%, c.14% and c.20% in 2014 respectively. HT stopped offering low-tier speed-capped plan in FY14. It has lost c.900 mobile sub since then (from 3,771k by the end of FY13 to 2,869k by the end of Jun 2015). Mobile post-paid subs decreased by c.390k from 1,933m by end of FY13 to 1,542m by end of Jun 2015. We expect the mobile sub loss to slow down in FY16F. Availability of “star” handsets. Handset sales depend on the popularity of the new smartphones. Availability of “star” handsets could result in higher handset sales volume and margin. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

Sub number (k)

Mobile ARPU (HK$)


3,771

3,197

2,702 2,729 2,756

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2013A 2014A 2015F 2016F 2017F

111117

127133 137

0

28

56

84

112

139

2013A 2014A 2015F 2016F 2017F


Page 3

Company Guide

Hutchison Telecom

Balance Sheet:

Healthy financial position with a net gearing ratio of 38%. The company generates stable operating cash flow. HT has a net gearing ratio of 32% and the debt-to-EBITDA ratio of c.1.5x in FY14. We expect HT to pay c.HK$1.8bn for 2.1GHz spectrum utilisation fees in FY16F. Thereafter, we expect a net gearing ratio of c.38%, which is healthy. Share Price Drivers:

Tariff hike. Operators have been able to raise mobile tariff in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. ARPU uplift will be a key share price catalyst. Mobile sub growth. Hong Kong mobile market penetration is more or less matured with low-single-digit sub growth in the past two years. Further sub growth will be mostly coming from market share gain. We believe that HT has to first slow down any sub loss, and then focus on growing its high-tier sub base. Availability of “star” handsets. Availability of “star” handsets could result in higher handset sales volume and margin. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

Key Risks:

Irrational market competition. Hong Kong mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Lack of “star” handsets. Handset sales depend on the popularity of the new smartphones. Lack of “star” handsets could result in lower handset sales volume and margins. And operators would have weaker pricing power to raise tariff for handset-bundled mobile data plans.

COMPANY BACKGROUND

Hutchison Telecom is an integrated telecom service provider in Hong Kong, operating under the brand “3 Hong Kong”. It has a c.23% mobile sub market share. Its major shareholder is CK Hutchison Holdings Limited.



ROE (%)

Forward PE Band

PB Band


0.6

0.7

0.7

0.8

0.8

0.9

0.9

0.00

0.10

0.20

0.30

0.40

0.50

2013A 2014A 2015F 2016F 2017F


1,050.0

1,100.0

1,150.0

1,200.0

1,250.0

1,300.0

1,350.0

1,400.0

1,450.0

2013A 2014A 2015F 2016F 2017F


HK$

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2013A 2014A 2015F 2016F 2017F

Avg: 17.4x

+1sd: 20x

+2sd: 22.6x

‐1sd: 14.8x

‐2sd: 12.2x

10.2

12.2

14.2

16.2

18.2

20.2

22.2

24.2

26.2


(x)

Avg: 1.45x

+1sd: 1.64x

+2sd: 1.82x

‐1sd: 1.27x

‐2sd: 1.08x

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3


(x)


Page 4

Company Guide

Hutchison Telecom

Key Assumptions

FY Dec 2013A 2014A 2015F 2016F 2017F Sub number (k) 3,771.0 3,197.0 2,702.0 2,729.0 2,756.3 Mobile ARPU (DBSV) 111.1 117.4 126.8 132.7 136.7


FY Dec 2013A 2014A 2015F 2016F 2017F Revenues (HK$ m) Moible 5,138 4,646 4,157 4,131 4,368 Fixed-line 3,418 3,664 3,607 3,723 3,846 Hardware sales 4,221 7,986 10,382 8,305 8,305 Total 12,777 16,296 18,145 16,160 16,519 Source: Company, DBS Vickers

Income Statement (HK$ m)

FY Dec 2013A 2014A 2015F 2016F 2017F Revenue 12,777 16,296 18,145 16,160 16,519 Cost of Goods Sold (3,943) (7,713) (10,164) (8,131) (8,131) Gross Profit 8,834 8,583 7,981 8,029 8,388

Other Opng (Exp)/Inc (7,495) (7,225) (6,587) (6,643) (6,932) Operating Profit 1,339 1,358 1,395 1,386 1,457

Other Non Opg (Exp)/Inc 0 0 0 0 0 Associates & JV Inc (12) (35) (10) (10) (10) Net Interest (Exp)/Inc (160) (155) (118) (150) (181) Dividend Income 0 0 0 0 0 Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 1,167 1,168 1,266 1,226 1,265

Tax (77) (205) (228) (221) (228) Minority Interest (174) (130) (130) (130) (130) Preference Dividend 0 0 0 0 0 Net Profit 916 833 908 875 908

Net Profit before Except. 916 833 908 875 908 EBITDA 2,662 2,644 2,731 2,772 2,891 Growth

Revenue Gth (%) (17.8) 27.5 11.3 (10.9) 2.2 EBITDA Gth (%) (11.4) (0.7) 3.3 1.5 4.3 Opg Profit Gth (%) (22.4) 1.4 2.7 (0.6) 5.1 Net Profit Gth (%) (24.6) (9.1) 9.1 (3.7) 3.7 Margins & Ratio

Gross Margins (%) 69.1 52.7 44.0 49.7 50.8 Opg Profit Margin (%) 10.5 8.3 7.7 8.6 8.8 Net Profit Margin (%) 7.2 5.1 5.0 5.4 5.5 ROAE (%) 8.3 7.5 8.0 7.5 7.6 ROA (%) 4.4 4.0 4.3 3.9 3.8 ROCE (%) 7.6 6.6 6.7 6.1 6.0 Div Payout Ratio (%) 75.0 74.9 75.0 75.0 75.0 Net Interest Cover (x) 8.4 8.8 11.8 9.2 8.0 Source: Company, DBS Vickers


Page 5

Company Guide

Hutchison Telecom


FY Dec 1H2013 2H2013 1H2014 2H2014 1H2015 Revenue 6,149 6,628 6,227 10,069 11,020 Cost of Goods Sold (1,668) (2,275) (2,060) (5,653) (6,975) Gross Profit 4,481 4,353 4,167 4,416 4,045 Other Oper. (Exp)/Inc (3,661) (3,834) (3,640) (3,585) (3,256) Operating Profit 820 519 527 831 789 Other Non Opg (Exp)/Inc 0 0 0 0 0

Associates & JV Inc (4) (8) (12) (23) (18)

Net Interest (Exp)/Inc (77) (83) (71) (84) (51) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 739 428 444 724 721 Tax (39) (38) (82) (123) (120) Minority Interest (128) (46) (39) (91) (92) Net Profit 572 344 323 510 508 Net profit bef Except. 572 344 323 510 509 Growth Revenue Gth (%) (8.6) (24.7) 1.3 51.9 77.0 Opg Profit Gth (%) 2.4 (43.9) (35.7) 60.1 49.7 Net Profit Gth (%) 0.7 (46.8) (43.5) 48.3 57.3 Margins Gross Margins (%) 72.9 65.7 66.9 43.9 36.7 Opg Profit Margins (%) 13.3 7.8 8.5 8.3 7.2 Net Profit Margins (%) 9.3 5.2 5.2 5.1 4.6 Source: Company, DBS Vickers


Page 6

Company Guide

Hutchison Telecom


FY Dec 2013A 2014A 2015F 2016F 2017F Net Fixed Assets 10,509 10,663 10,985 11,256 11,480 Invts in Associates & JVs 715 515 505 495 485 Other LT Assets 7,520 7,127 6,859 8,391 8,123 Cash & ST Invts 209 359 811 1,251 1,782 Inventory 171 142 149 157 164 Debtors 1,881 1,892 1,987 2,086 2,190 Other Current Assets 0 0 0 0 0


0 0 0 0 0 Creditors 3,981 3,956 3,956 3,956 3,956 Other Current Liab 14 18 18 18 18 LT Debt 4,571 3,952 3,952 5,752 5,752 Other LT Liabilities 1,103 1,063 1,279 1,488 1,703 Shareholder’s Equity 11,041 11,293 11,544 11,747 11,989 Minority Interests 295 416 546 676 806 Total Cap. & Liab. 21,005 20,698 21,295 23,636 24,225 Non-Cash Wkg. Capital (1,943) (1,940) (1,838) (1,732) (1,619) Net Cash/(Debt) (4,362) (3,593) (3,141) (4,501) (3,970) Debtors Turn (avg days) 56.0 42.3 39.0 46.0 47.2 Creditors Turn (avg days) 618.7 226.6 163.8 214.4 216.0 Inventory Turn (avg days) 26.0 8.9 6.0 8.3 8.8 Asset Turnover (x) 0.6 0.8 0.9 0.7 0.7 Current Ratio (x) 0.6 0.6 0.7 0.9 1.0 Quick Ratio (x) 0.5 0.6 0.7 0.8 1.0 Net Debt/Equity (X) 0.4 0.3 0.3 0.4 0.3 Net Debt/Equity ex MI (X) 0.4 0.3 0.3 0.4 0.3 Capex to Debt (%) 27.0 29.6 35.4 24.3 24.3 Z-Score (X) 1.5 1.8 1.9 1.7 1.7 Source: Company, DBS Vickers


FY Dec 2013A 2014A 2015F 2016F 2017F Pre-Tax Profit 1,167 1,168 1,266 1,226 1,265 Dep. & Amort. 1,335 1,321 1,346 1,396 1,445 Tax Paid (11) (12) (12) (12) (12) Assoc. & JV Inc/(loss) 12 35 10 10 10 (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. (832) (112) (102) (107) (112) Other Operating CF 64 83 (20) (20) (20)

Net Operating CF 1,735 2,483 2,489 2,493 2,576 Capital Exp.(net) (1,234) (1,168) (1,400) (1,400) (1,400) Other Invts.(net) 0 0 0 (1,800) 0 Invts in Assoc. & JV 0 0 0 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF (337) 85 20 20 20 Net Investing CF (1,571) (1,083) (1,380) (3,180) (1,380) Div Paid (929) (591) (657) (673) (665) Chg in Gross Debt 800 (650) 0 1,800 0 Capital Issues 0 0 0 0 0 Other Financing CF (8) (9) 0 0 0 Net Financing CF (137) (1,250) (657) 1,127 (665) Currency Adjustments 0 0 0 0 0 Chg in Cash 27 150 452 441 531 Opg CFPS (HK$) 0.53 0.54 0.54 0.54 0.56 Free CFPS (HK$) 0.10 0.27 0.23 0.23 0.24 Source: Company, DBS Vickers


Page 7

Company Guide

Hutchison Telecom


Source: DBS Vickers

1 2 3 4 5

2.02.22.42.62.83.03.23.43.63.84.0

No

v-1

4

Dec

-14

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5


Pric e Pric e1: 30-Jan-15 HK$3.53 HK$3.20 Hold2: 17-Feb-15 HK$3.46 HK$3.50 Hold3: 27-Jul-15 HK$3.43 HK$3.40 Hold4: 5-Aug-15 HK$3.35 HK$3.70 Hold5: 27-Oct-15 HK$3.04 HK$3.70 Hold


ed-TH/ sa- PY

BUY

Last Traded Price: HK$11.74 (HSI : 22,068) Price Target: HK$15.00 (28% upside) (Prev HK$17.00) Potential Catalyst: Price hike, avaliability of “star” handsets Where we differ: Our earnings estimates for FY6/15-FY6/16F are lower than concensus Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected] Price Relative

Forecasts and Valuation FY Jun (HK$ m) 2014A 2015A 2016F 2017FTurnover 13,244 18,659 13,822 14,008 EBITDA 2,456 2,857 2,878 3,013 Pre-tax Profit 663 1,131 1,058 1,158 Net Profit 537 935 875 958 Net Pft (Pre Ex) 537 935 875 958 EPS (HK$) 0.52 0.89 0.83 0.91 EPS Gth (%) (36.4) 72.6 (6.4) 9.5 Diluted EPS (HK$) 0.52 0.89 0.83 0.91 DPS (HK$) 0.31 0.60 0.62 0.68 BV Per Share (HK$) 3.08 3.64 3.86 4.12 PE (X) 22.7 13.2 14.1 12.9 P/Cash Flow (X) 5.7 4.2 4.3 4.3 P/Free CF (X) 9.2 5.6 5.7 5.6 EV/EBITDA (X) 4.9 3.9 4.5 4.1 Net Div Yield (%) 2.6 5.1 5.3 5.8 P/Book Value (X) 3.8 3.2 3.0 2.8 Net Debt/Equity (X) CASH CASH 0.1 CASH ROAE (%) 17.4 26.6 22.1 22.7 Earnings Rev (%): (0.5) 3.2 Consensus EPS (HK$) 0.88 0.91 Other Broker Recs: B: 10 S: 0 H: 3


ROBUST SERVICE REVENUE OUTLOOK A key beneficiary of tariff hike We have a BUY rating on SmarTone (SMT). SMT, being a smaller player, focuses on high-end subs. It is also adding lower-end subs without jeopardising its market position in the high-end market. As a pure mobile operator, SMT is the key beneficiary from the industry-wide tariff hike in the mobile market. Despite short-term downside risk from handset sales, outlook for core earnings from mobile services remains positive. Focusing on lower-tier and top-up plans SMT continues to benefit from the disciplined price competition environment. It has further raised the price for the 3G speed-capped plan by HK$10 or c.10% in FY15. We believe further tariff hikes will focus on the lower-tier plans to narrow the gap between lower-tier and high-tier plans to prevent trade downs. SMT also raised the price of the unlimited data top-up plan from HK$128 to HK$148 in 4Q15. Weak handset sales partly offset by growing mobile service Demand for iPhone 6S is lower than iPhone 6 in HK. We expect pretax earnings from handset sales to drop by more than 50% but it is partly offset by a c.28% increase in mobile service, resulting in a c.6% drop in the net profit to HK$875m for FY6/16F. We forecast the net profit to grow by 10% to HK$958m in FY6/17, driven by continuous ARPU increase. The company has raised its dividend payout ratio to 75% in 2H6/15 and the stock price currently offers c.5% dividend yield for FY6/16. Valuation:

We have a BUY rating on SMT as it is a beneficiary of mobile data tariff hike. It currently offers a decent dividend yield of c.5% for FY6/16. Our target price of HK$15.0 is pegged at 18x FY8/16F PE, which is in line with the historical average. Key Risks to Our View:

Irrational market competition. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Lack of “star” handsets. Handset sales depend on the popularity of the new smartphones. Lack of “star” handsets could result in lower handset sales volume and margins. And operators would have weaker pricing power to raise the tariffs for handset-bundled mobile data plans.


Major Shareholders Sun Hung Kai Properties Limited (%) 67.0


43

63

83

103

123

143

163

183

203

6.7

8.7

10.7

12.7

14.7

16.7

18.7

Nov-11 Nov-12 Nov-13 Nov-14 Nov-15

Relative IndexHK$

SmarTone (LHS) Relative HSI INDEX (RHS)



SmarTone Edition 1 Version 1 |Bloomberg: 315 HK EQUITY | Reuters: 315.HK



Page 2

Company Guide

SmarTone


Earnings Drivers:

Tariff hike. The competitive environment has improved since the merger of HKT and CSL. Operators have been able to raise the tariffs for mobile data plans in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. SMT has further increased the price for the 3G speed-capped plan from HK$78 to HK$88 per month in FY15. It has also increased the price of its unlimited data top-up plan from HK$128 to HK$148. ARPU uplift will be a key earnings growth driver. Mobile sub growth. Hong Kong's mobile market is more or less matured with low-single-digit sub growth in the past two years. There are four major players: HKT, Hutchison Telecom, SmarTone and China Mobile Hong Kong with market shares of c.33%, c.20%, c.14% and c.20% in 2014 respectively. SMT has a total sub base of 1,960m in FY6/15 with c.70% post-paid subs and c.30% prepaid subs. Speed-capped plan subs accounted for 1/3 of post paid sub base, and mid-to-high end subs accounted for the remaining 2/3. We believe that SMT will continue to grow its mobile sub base, in particular the lower-tier segment where it has less penetration. Availability of “star” handsets. Handset sales depend on the popularity of the new smartphones. Availability of “star” handsets could result in higher handset sales volume and margins. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

Sub base (k)

ARPU (HK$)


273

244 241250 253

0

56

111

167

223

278

2013A 2014A 2015A 2016F 2017F

1,8201,880

1,960 2,010 2,040

0

300

600

900

1,200

1,500

1,800

2013A 2014A 2015A 2016F 2017F


Page 3

Company Guide

SmarTone

Balance Sheet:

Strong balance sheet to support mobile spectrum fee. SMT has a strong balance sheet with a net cash position of HK$1.2bn by end of FY6/15. We expect SMT to pay c.HK$2.3bn for the 2.1GHz spectrum utilisation fees in FY6/16F. Thereafter, we expect a net gearing ratio of 16%, which is healthy. Share Price Drivers:

Tariff hike. Operators have been able to raise mobile tariff in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. ARPU uplift will be a key share price catalyst. Mobile sub growth. Hong Kong mobile market penetration is more or less matured with low-single-digit sub growth in the past two years. Further sub growth will be mostly coming from market share gain. We believe that SMT will continue to grow its mobile sub base, in particular the lower-tier segment where it has less penetration. Availability of “star” handsets. Availability of “star” handsets could result in higher handset sales volume and margins. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

Key Risks:

Irrational market competition. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Lack of “star” handsets. Handset sales depend on the popularity of the new smartphones. Lack of “star” handsets could result in lower handset sales volume and margins. And operators would have weaker pricing power to raise tariffs for handset-bundled mobile data plans.

COMPANY BACKGROUND

Smartone is a mobile operator in Hong Kong focusing on the high-end customer segment. It has a c.14% mobile sub market share. It also provides fixed-line broadband services through partnership with HKBN. Its major shareholder is Sun Hung Kai Properties.



ROE

Forward PE Band

PB Band


1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

2013A 2014A 2015A 2016F 2017F


0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

2013A 2014A 2015A 2016F 2017F


HK$

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2013A 2014A 2015A 2016F 2017F

Avg: 16.9x

+1sd: 21x

+2sd: 25x

‐1sd: 12.8x

‐2sd: 8.7x7.8

12.8

17.8

22.8

27.8


(x)

Avg: 4.1x

+1sd: 4.95x

+2sd: 5.79x

‐1sd: 3.25x

‐2sd: 2.41x2.1

2.6

3.1

3.6

4.1

4.6

5.1

5.6

6.1


(x)


Page 4

Company Guide

SmarTone

Key Assumptions

FY Jun 2013A 2014A 2015A 2016F 2017F Sub base (k) 1,820.0 1,880.0 1,960.0 2,010.0 2,040.0 ARPU 272.7 244.3 241.5 250.4 253.1


FY Jun 2013A 2014A 2015A 2016F 2017F Revenues (HK$ m) Mobile service 5,657 5,423 5,564 5,965 6,151 Handset and accessory sales

6,410 7,822 13,095 7,857 7,857

Total 12,067 13,244 18,659 13,822 14,008 Source: Company, DBS Vickers

Income Statement (HK$ m) FY Jun 2013A 2014A 2015A 2016F 2017F Revenue 12,067 13,244 18,659 13,822 14,008 Cost of Goods Sold (6,214) (7,743) (12,708) (7,755) (7,755) Gross Profit 5,852 5,502 5,951 6,067 6,253

Other Opng (Exp)/Inc (4,829) (4,801) (4,782) (4,955) (5,023) Operating Profit 1,023 700 1,169 1,112 1,230 Other Non Opg (Exp)/Inc 0 0 0 0 0 Associates & JV Inc 0 0 0 0 0 Net Interest (Exp)/Inc (8) (38) (39) (55) (72) Dividend Income 0 0 0 0 0 Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 1,015 663 1,131 1,058 1,158

Tax (167) (131) (195) (183) (200) Minority Interest (5) 5 0 0 0 Preference Dividend 0 0 0 0 0 Net Profit 843 537 935 875 958

Net Profit before Except. 843 537 935 875 958 EBITDA 2,876 2,456 2,857 2,878 3,013 Growth

Revenue Gth (%) 21.2 9.8 40.9 (25.9) 1.3 EBITDA Gth (%) 0.6 (14.6) 16.3 0.7 4.7 Opg Profit Gth (%) (16.8) (31.6) 67.0 (4.8) 10.6 Net Profit Gth (%) (17.6) (36.3) 74.2 (6.4) 9.5 Margins & Ratio

Gross Margins (%) 48.5 41.5 31.9 43.9 44.6 Opg Profit Margin (%) 8.5 5.3 6.3 8.0 8.8 Net Profit Margin (%) 7.0 4.1 5.0 6.3 6.8 ROAE (%) 27.7 17.4 26.6 22.1 22.7 ROA (%) 9.9 5.5 9.1 8.0 8.7 ROCE (%) 14.8 8.1 13.3 11.9 12.9 Div Payout Ratio (%) 81.2 60.1 67.8 75.0 75.0 Net Interest Cover (x) 132.8 18.6 30.3 20.4 17.1 Source: Company, DBS Vickers


Page 5

Company Guide

SmarTone


FY Jun 2H2013 1H2014 2H2014 1H2015 2H2015 Revenue 6,178 6,531 6,713 8,673 9,986 Cost of Goods Sold (3,287) (3,702) (4,041) (5,675) (7,032) Gross Profit 2,891 2,829 2,672 2,997 2,954 Other Oper. (Exp)/Inc (2,386) (2,399) (2,296) (2,375) (2,333) Operating Profit 506 431 377 623 621 Other Non Opg (Exp)/Inc 0 0 0 0 0

Associates & JV Inc 0 0 0 0 0

Net Interest (Exp)/Inc (47) (66) (78) (59) (54) Exceptional Gain/(Loss) 0 0 0 0 0 Pre-tax Profit 459 364 298 564 567 Tax (77) (56) (75) (96) (99) Minority Interest 1 3 2 (1) 1 Net Profit 384 311 226 466 469 Net profit bef Except. 384 311 226 466 469 Growth Revenue Gth (%) 26.3 10.9 8.7 32.8 48.7 Opg Profit Gth (%) (29.9) (30.2) (25.5) 44.5 64.9 Net Profit Gth (%) (29.9) (32.2) (41.2) 49.8 107.7 Margins Gross Margins (%) 46.8 43.3 39.8 34.6 29.6 Opg Profit Margins (%) 8.2 6.6 5.6 7.2 6.2 Net Profit Margins (%) 6.2 4.8 3.4 5.4 4.7 Source: Company, DBS Vickers


Page 6

Company Guide

SmarTone


FY Jun 2013A 2014A 2015A 2016F 2017F Net Fixed Assets 3,201 3,411 3,354 3,259 3,116 Invts in Associates & JVs 0 0 0 0 0 Other LT Assets 3,077 2,464 2,424 4,510 4,290 Cash & ST Invts 2,514 3,169 4,155 2,423 3,011 Inventory 103 80 82 82 82 Debtors 399 436 332 254 194 Other Current Assets 335 232 466 466 466


65 101 124 124 124 Creditors 537 778 755 732 711 Other Current Liab 2,094 2,070 2,413 2,459 2,447 LT Debt 2,530 2,739 2,844 2,844 2,844 Other LT Liabilities 1,354 854 770 696 621 Shareholder’s Equity 2,986 3,193 3,851 4,082 4,355 Minority Interests 62 57 57 57 56 Total Cap. & Liab. 9,628 9,792 10,814 10,995 11,159 Non-Cash Wkg. Capital (1,794) (2,100) (2,287) (2,389) (2,415) Net Cash/(Debt) (81) 329 1,186 (546) 42 Debtors Turn (avg days) 11.2 11.5 7.5 7.7 5.8 Creditors Turn (avg days) 48.2 40.1 25.4 45.3 44.1 Inventory Turn (avg days) 15.0 5.6 2.7 5.0 5.0 Asset Turnover (x) 1.4 1.4 1.8 1.3 1.3 Current Ratio (x) 1.2 1.3 1.5 1.0 1.1 Quick Ratio (x) 1.1 1.2 1.4 0.8 1.0 Net Debt/Equity (X) 0.0 CASH CASH 0.1 CASH Net Debt/Equity ex MI (X) 0.0 CASH CASH 0.1 CASH Capex to Debt (%) 48.4 29.0 25.5 22.9 22.9 Z-Score (X) 3.4 3.4 3.9 3.4 3.5 Source: Company, DBS Vickers


Page 7

Company Guide

SmarTone


FY Jun 2013A 2014A 2015A 2016F 2017F Pre-Tax Profit 1,015 663 1,131 1,058 1,158 Dep. & Amort. 1,717 1,627 1,480 1,575 1,593 Tax Paid (9) (181) (258) (183) (200) Assoc. & JV Inc/(loss) 0 0 0 0 0 (Pft)/ Loss on disposal of FAs 0 0 0 0 0 Chg in Wkg.Cap. (334) (153) 359 142 64 Other Operating CF 252 198 236 257 257

Net Operating CF 2,641 2,154 2,947 2,849 2,872 Capital Exp.(net) (1,255) (824) (757) (680) (680) Other Invts.(net) (1,873) (665) (1,117) (3,255) (918) Invts in Assoc. & JV 78 0 0 0 0 Div from Assoc & JV 0 0 0 0 0 Other Investing CF (1,744) 629 (444) (1) (1) Net Investing CF (4,795) (860) (2,319) (3,936) (1,599) Div Paid (998) (285) (392) (645) (685) Chg in Gross Debt 2,526 236 116 0 0 Capital Issues (50) 2 110 0 0 Other Financing CF 52 (57) 4 0 0 Net Financing CF 1,531 (104) (163) (645) (685) Currency Adjustments 0 0 1 0 0 Chg in Cash (623) 1,191 467 (1,732) 588 Opg CFPS (HK$) 2.87 2.22 2.47 2.58 2.68 Free CFPS (HK$) 1.34 1.28 2.09 2.07 2.09 Source: Company, DBS Vickers


Source: DBS Vickers

1 23

4 5

10.0

11.0

12.0

13.0

14.0

15.0

16.0

17.0

No

v-1

4

Dec

-14

Jan

-15

Feb

-15

Mar

-15

Ap

r-1

5

May

-15

Jun

-15

Jul-

15

Au

g-1

5

Sep

-15

Oct

-15

No

v-1

5


Pric e Pric e1: 30-Jan-15 HK$13.40 HK$16.00 Buy2: 18-Feb-15 HK$13.00 HK$16.00 Buy3: 27-Jul-15 HK$15.34 HK$16.00 Buy4: 2-Sep-15 HK$14.28 HK$17.00 Buy5: 19-Oct-15 HK$13.94 HK$17.00 Buy

Industry Focus


Page 37

DBSV recommendations are based an Absolute Total Return* Rating system, defined as follows:

STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)

BUY (>15% total return over the next 12 months for small caps, >10% for large caps)

HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)

FULLY VALUED (negative total return i.e. > -10% over the next 12 months)

SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

GENERAL DISCLOSURE/DISCLAIMER

This report is prepared by DBS Vickers (Hong Kong) Limited (DBSVHK) This report is solely intended for the clients of DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd and DBSVHK, its respective connected and associated corporations and affiliates (collectively, the “DBS Vickers Group”) only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSVHK. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Vickers Group, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the “DBS Group”)) do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the company (or companies) referred to in this report. The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and (b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments stated therein. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report. DBS Vickers Securities (USA) Inc ("DBSVUSA")"), a U.S.-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making. ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly, or indirectly, related to specific recommendations or views expressed in this report. As of 27 November 2015, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold interests in the securities recommended in this report (“interest” includes direct or indirect ownership of securities). COMPANY-SPECIFIC / REGULATORY DISCLOSURES 1. DBS Bank Ltd., DBS Vickers Securities (Singapore) Pte Ltd (“DBSVS”), DBSVHK, their subsidiaries and/or other affiliates have

proprietary positions in HKTt Trust & Hkt Limited, Hutchison Telecommunications Hong Kong Holdings Limited, Smartone Telecommunications Holdings Ltd, HKBN Limited recommended in this report as of 25 Nov 2015.

Industry Focus


Page 38

1. Compensation for investment banking services: DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively.

RESTRICTIONS ON DISTRIBUTION

General This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

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Malaysia This report is distributed in Malaysia by AllianceDBS Research Sdn Bhd ("ADBSR"). Recipients of this report, received from ADBSR are to contact the undersigned at 603-2604 3333 in respect of any matters arising from or in connection with this report. In addition to the General Disclosure/Disclaimer found at the preceding page, recipients of this report are advised that ADBSR (the preparer of this report), its holding company Alliance Investment Bank Berhad, their respective connected and associated corporations, affiliates, their directors, officers, employees, agents and parties related or associated with any of them may have positions in, and may effect transactions in the securities mentioned herein and may also perform or seek to perform broking, investment banking/corporate advisory and other services for the subject companies. They may also have received compensation and/or seek to obtain compensation for broking, investment banking/corporate advisory and other services from the subject companies.

Wong Ming Tek, Executive Director, ADBSR

Singapore This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) or DBSVS (Company Regn No. 198600294G), both of which are Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd and/or DBSVS, may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, DBS Bank Ltd accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact DBS Bank Ltd at 6327 2288 for matters arising from, or in connection with the report.

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Dubai

This research report is being distributed in The Dubai International Financial Centre (“DIFC”) by DBS Bank Ltd., (DIFC Branch) having its office at PO Box 506538, 3rd Floor, Building 3, East Wing, Gate Precinct, Dubai International Financial Centre (DIFC), Dubai, United Arab Emirates. DBS Bank Ltd., (DIFC Branch) is regulated by The Dubai Financial Services Authority. This research report is intended only for professional clients (as defined in the DFSA rulebook) and no other person may act upon it.

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Other jurisdictions

In any other jurisdictions, except if otherwise restricted by laws or regulations, this report is intended only for qualified, professional, institutional or sophisticated investors as defined in the laws and regulations of such jurisdictions.

DBS Vickers (Hong Kong) Limited

18th Floor Man Yee building, 68 Des Voeux Road Central, Central, Hong Kong

Tel: (852) 2820-4888, Fax: (852) 2868-1523

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