Policy Focus Drives Steep Downside Telecom Services ...1).pdfChart 5: China Telecom’s DCF Valuation Source: Jefferies estimates, company data Chart 6: China Unicom’s Valuation

Mkt. Cap Price Cons. Current EPS Estimates Previous Est.Company Name Ticker (MM) Rating Price Target Next FY 2015 2016 2017 2016 2017 China Mobile Limited 941 HK $222,257.4 UNPF HK$84.20 HK$69.24 RMB5.29 RMB5.30 RMB5.45 RMB5.61 RMB5.45 RMB5.61China Telecom Corp Ltd. 728 HK $38,083.2 UNPF HK$3.65 HK$3.02 RMB0.25 RMB0.25 RMB0.25 RMB0.25 RMB0.25 RMB0.25China Unicom Ltd. 762 HK $27,816.1 UNPF HK$9.01 HK$7.26 RMB0.03 RMB0.44 RMB0.03 RMB(0.03) RMB0.03 RMB(0.03)

INDUSTRY NOTE

Assuming Coverage

China | Telecommunications | Telecom Services 21 November 2016

Telecom ServicesAssuming Coverage: Shareholder-unfriendlyPolicy Focus Drives Steep Downside

EQU

ITY R

ESEARC

H C

HIN

A

Source: OECD Digital Economy Outlook 2015,

company data, Jefferies

Source: Jefferies, company data

Source: IMF World Economic Outlook 2015,

www.dnaindia.com, company data, Jefferies

Source: Jefferies estimates

Edison Lee, CFA *Equity Analyst

+852 3743 8009 [email protected]

* Jefferies Hong Kong Limited

^Prior trading day's closing price unlessotherwise noted.

Key Takeaway

After multiple rounds of fund raising and restructuring, China's telecomindustry will likely be increasingly used as a tool to spur the growth of othersectors: supporting China's Internet+ and "Made in China 2025" initiatives.The government will likely continue pressing for lower prices, rapid coverageexpansion and ongoing technology and data speed upgrade. This will translateinto top line pressure and stubbornly high capex for all three telecomoperators.

With this report, Edison Lee assumes coverage of Jefferies’ telecoms coverage. We have anegative view on the sector driven by regulatory development.

Current industry structure seen as sustainable. After 20 years of partial privatization,multiple rounds of restructuring, fund raising and management reshuffles, we believe thegovernment sees the current industry structure as sustainable. In other words, the threeoperators are unlikely to get any asymmetric help or face any harm from the governmentin the near term.

Maximizing telecom profits no longer a priority. With no more equity fund raisingand restructuring required, the telecom policy focus in the next five years will likely be on1) lower prices, 2) rapid coverage expansion, and 3) continued data speed and technologyupgrade. This is to spur the growth of Internet services and encourage traditional industriesto utilize advanced IT technology.

Capex could remain stubbornly high. The three telecom operators’ capex to salesratios, which have stayed persistently high at 30% to 40%, are unlikely to fall substantiallywhile the telecoms revenue to GDP ratio will fall further (1.6%). Their top line growth willremain below GDP growth. The high capex explains why their EV/EBITDA multiples are low,and they may go even lower.

17% to 20% downside to the stock prices. Based on long-term capex to sales ratio of27% to 30%, our DCF-based TPs imply downside of 20%, 18% and 17% for China Unicom,China Mobile and China Telecom, respectively. Our 2017 earnings forecasts are also belowconsensus. Potential de-rating catalysts will be 1) weak EBITDA and profit growth in the nextfew quarters, 2) continued high capex guidance for 2017 (coming out in Mar/Apr 2017) and3) no dividend increase (for China Telecom and China Unicom) in the upcoming results. Inthe worst case, the market could revert to valuing these companies only on their dividends,and our DDM valuation is 32% to 61% below the current stock prices.

China Mobile - Its DCF is the least sensitive to capex because of its large cash pile. But itscontinued market dominance may invite more national services, and we see low likelihoodof a meaningful increase in dividend payout ratio.

China Telecom - Its DCF is the most sensitive to capex among the three operators. A rapidrise in capex in both fixed line and mobile, together with little EBITDA growth, will turn FCFnegative. Its ability to raise dividend is limited.

China Unicom - Its DCF is also very sensitive to capex because of its low operating margin.But its FCF will remain positive. Further margin pressure will likely force it to report a netloss in 2017.

Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 61 to 64 of this report.

Contents EXECUTIVE SUMMARY ................................................................................................................ 3 THE ART OF CHINESE REGULATION .............................................................................................. 9 FURTHER INDUSTRY CONSOLIDATION NOT IN SIGHT ................................................................. 12 WILL CAPEX EVER FALL? ............................................................................................................ 13 CONTINUED PRESSURE TO LOWER PRICES ................................................................................. 16 IS MOBILE DATA DEMAND IN CHINA PRICE ELASTIC? ................................................................. 18 LOW MORALE MAKES IMPROVEMENT EVEN HARDER ............................................................... 20 OUR VALUATION WORK SUGGESTS SIGNIFICANT DOWNSIDE .................................................... 21 CHINA MOBILE (941 HK) ............................................................................................................ 29

Entrenched market position as an incumbent ............................................................................ 29 A strong balance sheet allows rapid network build .................................................................... 29 Risk of asymmetric regulations is not all gone ............................................................................ 29 Dividend to exceed FCF; any big hike unlikely ............................................................................ 30 Valuation looks cheap but likely a value trap ............................................................................. 30

CHINA TELECOM (0728 HK) ........................................................................................................ 36 A large fixed line business has been a burden ............................................................................ 36 Margin will unlikely improve ...................................................................................................... 36 IDC, ICT and IPTV are bright spots, but not enough .................................................................... 36 FCF will be lower than forecast dividend payment ..................................................................... 37 DCF value highly sensitive to capex assumptions ....................................................................... 37

CHINA UNICOM (0762 HK) ......................................................................................................... 44 The new CEO could raise performance ....................................................................................... 44 Mobile is still a big challenge ...................................................................................................... 44 Fixed line is a smaller drag than at CT ......................................................................................... 44 Valuation unattractive on both DCF and multiples ..................................................................... 45 Excitement about PPP likely overdone ....................................................................................... 45

Telecommunications

Assuming Coverage

21 November 2016

page 2 of 64 , Equity Analyst, +852 3743 8009, [email protected] Lee, CFA

Please see important disclosure information on pages 61 - 64 of this report.

Executive Summary • With this report, Edison Lee assumes coverage of Jefferies’ telecom coverage. We have

a negative view on the sector driven by regulatory development.

• Chinese telcos’ profitability in the past 20 years has been heavily influenced by

government policies. Management has increased efficiency, streamlined operations and

improved governance. However, the magnitude of such an impact is small versus what

changes in regulations and policies have done.

• After 20 years of partial privatization, multiple rounds of restructuring, fund raising and

management reshuffle, we believe the government sees the current industry structure

sustainable. In other words, the three operators are unlikely to get any asymmetric help,

or face punishment, from the government in the near term.

• With no more equity fund raising and restructuring required, the telecom policy focus

in the next five years will likely be on 1) lower prices, 2) rapid coverage expansion, and 3)

continued data speed and technology upgrade. This is to support China’s Internet+ and

Made in China 2025 initiatives.

• In other words, Chinese telcos’ capex to sales ratio, which has been consistently high

(30% to 40%), will likely stay high longer term while the telecoms revenue to GDP ratio

will be low (1.6%). Their top line growth will remain below GDP growth. Owing to high

capex, their EV/EBITDA multiples are also justifiably low.

• We see many analysts’ high DCF valuations, driven by a fall in the long-term capex to

sales ratio to 20%-25% as very risky. We believe 27% to 30% is much more likely. Our TPs,

which are based on DCF estimates, imply downside of 20%, 18% and 17% for China

Unicom, China Mobile and China Telecom, respectively. Our 2017 earnings forecasts are

also below consensus. Potential de-rating catalysts will be 1) weak EBITDA and profit

growth in the next few quarters, 2) continued high capex guidance for 2017 (coming out

in Mar/Apr 2017) and 3) no dividend increase (for China Telecom and China Unicom) in

the upcoming results. The single biggest risk to our call is a massive cut in capex for these

operators in their 2017 guidance.

A more extreme, negative scenario is that the market may start valuing these stocks just

on the basis of the dividends, since investors may start feeling that minority shareholders

have no control over the use of these telcos’ FCF, and these SOEs are not for sale. That

could make DCF valuation less relevant for financial investors. On a DDM basis, our

valuation is 34% to 60% lower than the current stock prices.

Chart 1: Valuation Comparison

Source: Jefferies estimates, company data

Current 2016E Net

Stock Ticker stock px JEF rating JEF PT Mcap (US$m) 16E 17E 16E 17E 16E 17E 16E 17E 16E 17E 16E 17E Revenue EBITDA EPS debt to equity

China Mobile 941.HK 84.6 Upf 69.24 223,513 13.6 13.2 4.3 4.0 1.5 1.5 11.7% 11.4% 2.0 2.0 17.0% 16.9% 3.3% 2.3% -5.8% -43%

China Telecom 728.HK 3.65 Upf 3.02 38,117 13.0 12.6 3.5 3.3 0.8 0.8 6.4% 6.3% 0.9 0.8 5.8% 5.6% 2.5% 3.1% -1.0% 27%

China Unicom 762.HK 9.07 Upf 7.26 28,026 248.3 -266.4 4.1 4.2 0.8 0.9 0.3% -0.3% 1.1 1.1 1.1% 0.4% 2.3% 2.8% 9.9% 62%

P/B ROAE EV/IC ROIC CAGR 16E-19EPE EV/EBITDA

Government policies determine

telecom operators’ profitability in

China

Expect no more industry

restructuring

Regulatory focus is likely on lower

prices, wider network coverage and

ongoing tech and speed upgrade

Capex to sales will remain high;

telecom revenue to GDP will fall

Our LT capex to sales assumptions

are 27%-30%. Our DCF-based TPs

imply 17%-20% downside to stock

prices.

If capex remains high and dividends

do not grow, the worst case is to

revert to a DDM valuation.

Telecommunications

Assuming Coverage

21 November 2016



Chart 2: China Mobile’s Valuation Summary


Chart 3: China Mobile’s DCF Valuation


Chart 4: China Telecom’s Valuation Summary


Chart 5: China Telecom’s DCF Valuation


Chart 6: China Unicom’s Valuation Summary


Chart 7: China Unicom’s DCF Valuation


Dec 31, Rmb m 2014A 2015A 2016E 2017E 2018E 2019E

Revenue 651,509 668,335 719,450 769,215 769,486 793,690

EBITDA 240,237 240,028 257,485 273,467 283,309 275,286

vs concensus 0.7% 0.5%

Net profit 109,218 108,539 111,521 114,799 111,832 93,078

Basic EPS (Rmb) 5.38 5.30 5.45 5.61 5.46 4.55

vs concensus 3.0% -2.3%

EPS growth -7.4% -1.5% 2.7% 2.9% -2.6% -16.8%

PE 13.8 14.0 13.6 13.2 13.6 16.3

EV/EBITDA 4.6 4.6 4.3 4.0 3.9 4.0

ROAE 13.0% 12.0% 11.7% 11.4% 10.4% 8.3%

ROIC 21.3% 15.7% 17.0% 16.9% 15.4% 11.3%

Dividend yield 3.1% 3.0% 3.42% 3.42% 3.42% 3.42%

P/B 1.7 1.6 1.5 1.5 1.4 1.3

EV/IC 2.6 2.2 2.0 2.0 1.9 1.8

FCF yield to market cap 2.8% 4.1% 3.9% 3.0% 2.2% 3.6%

WACC and Terminal Value Calculation

Risk free rate 1.40% Terminal growth rate 3.2%

Equity risk premium 7.80% Terminal FCF x 21.8

Beta 0.82 Terminal value 805,720

CoE 7.8% Terminal EV/EBITDA 3.0

Cost of debt NA

After-tax cost of debt NA

WACC 7.8%

DCF Valuation (Rmb m) 2016E 2017E 2018E 2019E 2020E

EBITDA 257,485 273,467 283,309 275,286 269,524

Change in working capital 23,035 4,283 (4,314) 20,113 (736)

Operating profit x tax rate (29,079) (29,670) (28,373) (22,331) (17,406)

Capex (186,000) (196,332) (209,574) (211,907) (215,499)

Unleveraged FCF 65,441 51,749 41,048 61,161 35,883

Unleveraged FCF + terminal value 65,441 51,749 41,048 61,161 841,603

Discount period 0 1 2 3 4

Discount factor 1.00 0.93 0.86 0.80 0.74

PV of unleveraged FCF 65,441 48,006 35,325 48,827 623,299

Enterprise value (Rmb m) 820,899

Less: net debt (end of 2016) (420,672)

Equity value (Rmb m) 1,241,572

Equity value per share (Rmb) 60.6

Equity value per share (HK$) 69.24

Dec 31, Rmb m 2014A 2015A 2016E 2017E 2018E 2019E

Revenue 324,394 331,202 358,486 373,456 383,507 386,073

EBITDA 94,853 94,106 98,134 102,804 106,706 107,400

vs consensus 1.6% 0.8%

Net profit 17,680 20,054 19,856 20,525 20,576 19,284

Basic EPS (Rmb) 0.22 0.25 0.25 0.25 0.25 0.24

vs consensus 2.2% -6.1%

EPS growth 0.8% 13.4% -1.0% 3.4% 0.2% -6.3%

PE 14.6 12.9 13.0 12.6 12.6 13.4

EV/EBITDA 3.6 3.6 3.5 3.3 3.2 3.2

ROAE 6.2% 6.7% 6.4% 6.3% 6.1% 5.5%

ROIC 5.8% 5.2% 5.8% 5.6% 5.3% 4.8%

Dividend yield 2.4% 2.4% 2.8% 2.8% 2.8% 2.8%

P/B 0.89 0.85 0.81 0.78 0.75 0.73

EV/IC 0.92 0.90 0.86 0.82 0.78 0.75

FCF yield to market cap 6.2% 2.6% 1.9% -0.9% -0.7% 1.6%


Risk free rate 1.40% WACC 8.0%

Equity risk premium 7.80% Terminal growth rate 6.1%

Beta 1.05 Terminal FCF x 52.2

CoE 9.6% Implied terminal EV/EBITDA x 3.5

Cost of debt 4.0% Terminal value (Rmb m) 375,805

After-tax cost of debt 3.0%

WACC 8.0%

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 98,134 102,804 106,706 107,400 106,781

Change in working capital 14,260 1,187 (1,685) 1,068 1,207


Capex (97,000) (95,500) (95,632) (93,174) (94,246)

Unleveraged FCF 7,986 1,039 1,944 8,214 7,197



Discount factor 1.00 0.93 0.86 0.79 0.73

PV of unleveraged FCF 7,986 962 1,666 6,518 281,360


Less: net debt (end of 2016) 84,535

Equity value (Rmb m) 213,957



Dec 31, Rmb m 2014A 2015A 2016E 2017E 2018E 2019E

Revenue 284,681 277,049 278,759 283,391 289,133 298,163

EBITDA 92,771 87,502 81,593 79,736 87,685 88,701

vs consensus -1.8% -10.9%

Net profit 12,055 10,562 766 (714) 2,781 1,016

Basic EPS (Rmb) 0.51 0.44 0.03 (0.03) 0.12 0.04

vs consensus -76% -110%

EPS growth 15.9% -13.7% -92.7% -193.2% -489.5% -63.5%

PE 15.6 18.1 248.3 (266.4) 68.4 187.2

EV/EBITDA 3.6 3.8 4.1 4.2 3.8 3.7

ROAE 5.4% 4.6% 0.3% -0.3% 1.3% 0.5%

ROIC 5.2% 2.9% 1.1% 0.4% 1.5% 0.7%

Dividend yield 2.5% 2.1% 2.5% 2.5% 2.5% 2.5%

P/B 0.84 0.82 0.84 0.86 0.86 0.88

EV/IC 1.2 1.2 1.1 1.1 1.2 1.3

FCF yield to market cap 9.7% -2.2% -5.9% 4.3% 8.3% 7.7%

WACC and Terminal Valuation Calculation


Equity risk premium 7.80% Terminal growth rate 2%





WACC 5.1%

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 81,593 79,736 87,685 88,701 88,141

Change in working capital (13,181) 6,306 8,951 6,899 (503)

Operating profit x tax rate (1,038) (355) (1,341) (618) 138

Capex (75,000) (73,920) (76,247) (77,289) (78,377)

Unleveraged FCF (7,625) 11,768 19,047 17,693 9,399

Unleveraged FCF + terminal value (7,625) 11,768 19,047 17,693 314,442


Discount factor 1.00 0.95 0.90 0.86 0.82

PV of unleveraged FCF (7,625) 11,193 17,229 15,221 257,290






Telecommunications

Assuming Coverage

21 November 2016



Chart 8: China Mobile’s DCF Valuation Sensitivity to Capex to Sales Ratio


Chart 9: China Telecom’s DCF Valuation Sensitivity to Capex to Sales Ratio


Chart 10: China Unicom’s DCF Valuation Sensitivity to Capex to Sales Ratio


Telecommunications

Assuming Coverage

21 November 2016



China Mobile (941 HK)

The least risky of the three Key Takeaway

CM's strong incumbent advantages and net cash position of Rmb420bn makes

it the least risky stock to own among the three, in our view. Its mobile market

share has stabilized at around 67% since 2014. The convergence of TDD and

FDD in 4G has helped CM retain high-end subscribers. Its DCF value is the least

sensitive to any further capex rise (or fall).

4G helped CM maintain its incumbent advantages. CM's incumbent advantages

were weakened substantially when it was required to offer 3G services using the China-

developed TD-SCDMA standard. Those handsets cannot be used outside China, nor on

Unicom's or CT's networks. However, since TDD and FDD can converge in 4G, a large

number of multi-mode and multi-band handsets came out, which helped CM regain its

competitive edge, and stabilized revenue market share.

A strong balance sheet helped rapid network build. Its Rmb420bn cash on hand

has allowed CM to rapidly build its 4G coverage after it was awarded a license in

December 2013. By the end of 2015, it had 1.2m 4G base stations, versus 520K at CT and

400K at Unicom. That has enabled CM to achieve 312m 4G users (38% of its user base),

much higher than CT's 58.5m (30%) and Unicom's 44m (18%). Its advantage will likely

be repeated when 5G services are rolled out.

Meaningful dividend hike unlikely, to prepare for future investments. Despite

its massive net cash position, we do not believe management is motivated to

meaningfully hike its dividend payout ratio. Since it is hard to further reduce CM's market

dominance by industry restructuring, the government's likely solution is to keep asking

CM to perform national services, such as faster expansion, coverage in remote areas and

constant technology upgrade. Therefore, management, either at its own discretion or

under the government's influence, would like to keep as much cash as possible.

Valuation/Risks

CM is currently trading at 4.3x EV/EBITDA and 13.6x PE (or 10x excluding cash) for 2016.

While its earnings multiples look cheap, they would not fall as we forecast little growth in

EBITDA and profit. Its P/B of 1.5x and EV/IC of 2.0x is not particularly cheap either, against

1.5x ROAE/CoE and 2.2x ROIC/WACC. Our DCF value of HK$69.24 is based on a WACC of

7.8%, a terminal growth rate of 3.2% and a long-term capex to sales ratio of 30%.

Upside risks. The willingness of management to significantly increase dividend payout

for 2016 (even a one-time special dividend will be considered a disappointment) and a

large cut in capex guidance for 2017.

Downside risks. No capex cut and dividend increase in the upcoming 2016 result

announcement. Mobile data demand shows falling elasticity as prices continue to fall.

RMB Prev. 2015A Prev. 2016E Prev. 2017E Prev. 2018E

Rev. (MM) -- 668,335.0 -- 719,450.0 -- 769,215.0 -- 769,486.0

EBITDA (MM) -- 239,754.0 240,614.0 257,485.0 258,913.0 273,467.0 276,282.0 283,309.0

EV/EBITDA 4.6x 4.3x 4.1x 3.9x

Net Profit -- 108,539.0 -- 111,521.0 -- 114,799.0 -- 111,832.0

P/B -- 1.6x 1.9x 1.5x 1.8x 1.5x 1.7x 1.4x

ROE -- 12.0% -- 11.7% -- 11.4% -- 10.4%

ROIC -- 15.7% -- 17.0% -- 16.9% -- 15.4%

Div Yield -- 3.00% 2.20% 3.42% 2.50% 3.42% 2.80% 3.42%

Cons. EPS -- -- 5.34 5.29 5.85 5.74 6.49 6.23

EPS

FY Dec -- 5.30 4.78 5.45 5.35 5.61 5.89 5.46

FY P/E 14.2x 13.8x 13.4x 13.8x

U N D E R P E R F O R M

( f r o m B U Y )

P r ic e ta r g e t H K $ 6 9 .2 4

( f r o m H K $ 1 0 6 .8 0 )

P r ic e H K $ 8 4 .7 5

B lo o m b e r g : 9 4 1 H K

R e u te r s : 0 9 4 1 .H K

F in a n c ia l S u m m a r y

B o o k V a lu e ( M M ) : R m b 9 6 0 ,0 0 6 .0

B o o k V a lu e /S h a r e : R m b 4 6 .9 0

N e t D e b t ( M M ) : ( R m b 4 2 6 ,7 8 2 )

C a s h & S T In v e s t. ( M M ) : R m b 4 3 3 ,1 5 9 .0

M a r k e t D a t a

5 2 W e e k R a n g e : H K $ 9 9 .3 0 - H K $ 7 9 .0 0

T o ta l E n tp r s .V a lu e ( M M ) $ 1 6 1 .7 2 7 .2

M a r k e t C a p . ( M M ) : $ 2 2 3 ,6 8 7 .4

S h a r e s O u t. ( M M ) : 2 0 ,4 7 3 .0

F lo a t ( M M ) : 5 ,5 8 4 .1

A v g . D a ily V o l. : 1 4 ,0 0 7 ,6 3 0 .0

Price Performance

Source: Bloomberg

70

75

80

85

90

95

100

105

110

Nov-15 Feb-16 May-16 Aug-16

Telecommunications

Assuming Coverage

21 November 2016



China Telecom (728 HK)

Most vulnerable to high capex Key Takeaway

CT became an integrated operator in 2008 by buying the CDMA business from

Unicom. It was awarded an FDD-LTE 4G license in 2015. Its capex has doubled

to Rmb105bn last year from 2012, driven by broadband expansion, 3G and

then 4G network build. Falling operating cash flow and still high capex will

cause FCF to turn negative. Our DCF valuation implies 17% downside, and it is

the most sensitive to capex assumptions among the three.

A large fixed line business is a burden. Being the incumbent fixed line operator in 21

southern provinces, revenue of fixed line voice accounted for as much as 30% of its

service revenue in 2010. Owing to mobile substitution, its revenue of fixed line voice has

fallen by Rmb32bn from 2010 to 2015, but fortunately it has been offset by growth in

broadband, IDC, ICT and leased line to produce overall flat growth in fixed line revenue.

In other words, all top-line growth has come from the mobile business.

Margin will unlikely improve. Since 2012, CT's mobile subscriber market share has

risen from 14.9% to 15.9%, but its revenue market share has impressively gone up from

11.8% to 15.1%, thanks to effective fixed-mobile bundling and rapid rollout of 3G and 4G

services. However, its revenue market share in mobile is still 80 bps below its subscriber

market share. That is due to CM's strong incumbent advantages. We do not forecast this

situation will change. Given CT has a large fixed line business, its EBITDA margin is the

lowest among the three operators. We forecast its EBITDA will remain the lowest and

continue to be under pressure.

Financially constrained to raise dividends. For 2015, CT generated enough FCF to

pay dividends. Its FCF in 2016 is forecast to fall by Rmb2.0bn, and it will be less than even

the 2015 dividend payment. Since we have factored in a 15% increase in DPS for all three

companies, its FCF in 2017 will fall short of projected dividend payment by Rmb2.3bn.

Moreover, CT will need to pay its parent Rmb61bn in 2017 as the last instalment for its

purchase of the CDMA network in 2012. Although that could be deferred, we see a real

risk of a dividend cut in 2018 and 2019.

Valuation/Risks

CT is trading at 13.0x PE and 3.5x EV/EBITDA for 2016, but against little growth in EBITDA

and net profit according to our forecasts. Its P/B of 0.81x and EV/IC of 0.86x are

unattractive against its ROAE/CoE ratio of 0.67x and ROIC/WACC ratio of 0.73,

respectively. Our DCF value of HK$3.02 per share is based on a WACC of 8%, a terminal

growth rate of 6% (translating into 3.5x EV/EBITDA) and a long-term capex to sales ratio

of 27%. Every one percentage point change in capex to sales will move the DCF value by

roughly HK$1.90 per share.

Upside risks. 1) a large capex cut in 2017, 2) a large dividend increase., 3) China Tower

Corp. is able to do an IPO at a very high valuation, and 4) a government-engineered

merger with Unicom

Downside risks. 2) little reduction in its 2017 capex guidance, 2) no dividend increase,

3) mobile data demand shows falling elasticity as prices continue to fall.


Rev. (MM) -- 331,202.0 -- 358,486.0 -- 373,456.0 -- 383,507.0

EBITDA (MM) -- 94,106.0 94,035.0 98,134.0 97,581.0 102,804.0 103,489.0 106,706.0


Net Profit -- 20,054.0 -- 19,856.0 -- 20,525.0 -- 20,576.0

P/B -- 0.9x -- 0.8x -- 0.8x 0.7x 0.8x

ROE -- 6.7% -- 6.4% -- 6.3% -- 6.1%

EPS

FY Dec -- 0.25 0.24 0.25 0.24 0.25 0.27 0.25

FY P/E 13.0x 13.0x 13.0x 13.0x


( f r o m B U Y )

P r ic e ta r g e t H K $ 3 .0 2

( f r o m H K $ 4 .4 0 )

P r ic e H K $ 3 .6 5

B lo o m b e r g : 7 2 8 H K

R e u te r s : 0 7 2 8 .H K


B o o k V a lu e ( M M ) : R m b 3 0 9 ,8 0 0 .0

B o o k V a lu e /S h a r e : R m b 3 .8 3

N e t D e b t ( M M ) : R m b 7 5 ,9 5 9

R e tu r n o n A v g . E q u ity : 5 .6 %

C a s h & S T In v e s t. ( M M ) : R m b 3 0 ,0 7 6 .0

M a r k e t D a t a

5 2 W e e k R a n g e : H K $ 4 .3 4 - H K $ 3 .2 8

T o ta l E n tp r s .V a lu e ( M M ) $ 4 9 ,1 1 0 .9

M a r k e t C a p . ( M M ) : $ 3 8 ,0 8 3 .2

S h a r e s O u t. ( M M ) : 8 0 ,9 3 2 .0

F lo a t ( M M ) : 1 3 ,8 7 7 .4

A v g . D a ily V o l. : 5 4 ,9 1 6 ,9 7 0 .0

Price Performance

Source: Bloomberg

3

3.2

3.4

3.6

3.8

4

4.2

4.4


Telecommunications

Assuming Coverage

21 November 2016



China Unicom (762 HK)

A turnaround constrained by government policies Key Takeaway

Unicom's mobile business has faced tough challenges from both CM and CT.

CT has effectively bundled fixed line broadband with its mobile to take share

in higher-ARPU users in the 21 southern provinces. But Unicom's much

smaller fixed line business also created a smaller drag on return. We forecast

its FCF will exceed dividend payment, but its high gearing still makes

dividend increase unlikely. Recent excitement about a potential strategic

investor is overdone.

The new CEO could raise performance. In 2015, CT's CEO (Chairman Wang)

became Unicom's CEO under another government-directed reshuffle. Chairman Wang

has an excellent track record at both CT and CM. His rich experience allowed him to

quickly implement improvement initiatives at Unicom. However, many structural issues

and deep-rooted practices of Unicom cannot be changed just because of a new CEO.

After reporting good 1H16 results, its 3Q16 results were disappointing. The current lack

of financial incentives in the industry will also make significant improvements harder to

achieve.

Mobile is still a big challenge. Unicom's weak market position in mobile was driven

by its dual-network status and capital constraint at the start. Even though it sold its CDMA

business in 2008 and focused on the GSM-based network, the network quality and

coverage gap with CM will takes years to narrow. After Chairman Wang joined, he

accelerated the 4G rollout. However, Unicom's revenue market share in mobile in fact fell

from 17.4% in 2015 to 16.4% in 1H16. The mobile business remains an uphill battle for

Unicom.

Excitement about PPP likely overdone. Since Unicom was included by the NDRC in

the Public-Private-Partnership (PPP) pilot project, there has been rampant speculation that

one of the large Chinese Internet companies may take a stake in Unicom. We see limited

synergies in such a deal, and expect significant challenges in how the private investor can

influence Unicom's operations. Bear in mind Telefonica has yet to sell its remaining 1.5%

stake in Unicom (started at 9.6%), partly because there has been little tangible benefit

after seven years.

Valuation/Risks

Our DCF valuation of HK$7.26 per share is based on a WACC of 5.1%, a terminal growth

rate of 2% (3.5x EV/EBITDA) and a long-term capex to sales ratio of 30%. It is expensive

trading at 0.84x P/B against only 0.04x ROAE/CoE, and 1.1x EV/IC against.

Upside risks. 1) A large cut in its capex guidance for 2017, 2) a government-engineered

merger with CT, and 3) if a Chinese Internet company takes a strategic stake in Unicom at

a premium to the current stock price, Unicom’s stock price can rise in the short term.

Downside risks. 1) little reduction in its 2017 capex guidance, 2) no dividend increase

for 2016, 3) mobile data demand shows falling elasticity as prices continue to fall, 4) no

news in strategic investors nor merger with CT.


Rev. (MM) -- 277,049.0 -- 278,759.0 -- 283,391.0 -- 289,133.0

EBITDA (MM) -- 87,502.0 74,610.0 81,593.0 84,784.0 79,736.0 92,594.0 87,685.0


Net Profit -- 10,562.0 -- 766.0 -- (714.0) -- 2,781.0

P/B 0.8x 0.8x 0.9x 0.9x

ROE -- 4.6% 1.0% 0.3% 3.2% -0.3% 4.8% 1.3%

ROIC -- 2.9% -- 1.1% -- 0.4% -- 1.5%

EPS

FY Dec -- 0.44 0.10 0.03 0.32 -0.03 0.49 0.12

FY P/E 18.3x NM NM 68.4x


( f r o m H O L D )

P r ic e ta r g e t H K $ 7 .2 6

( f r o m H K $ 9 .0 0 )

P r ic e H K $ 9 .0 7

B lo o m b e r g : 7 6 2 H K

R e u te r s : 0 7 6 2 .H K


B o o k V a lu e ( M M ) : R m b 2 2 7 ,9 7 6 .0

B o o k V a lu e /S h a r e : R m b 9 .5 2

N e t D e b t ( M M ) : R m b 1 3 1 ,3 7 5

R e tu r n o n A v g . E q u ity : 4 .6 %

L o n g -T e r m D e b t ( M M ) : R m b 4 0 ,2 6 0 .0

C a s h & S T In v e s t. ( M M ) : R m b 2 1 ,2 1 4 .0

M a r k e t D a t a

5 2 W e e k R a n g e : H K $ 1 0 .2 6 - H K $ 7 .7 0

T o ta l E n tp r s .V a lu e ( M M ) $ 4 7 ,0 7 4 .4

M a r k e t C a p . ( M M ) : $ 2 8 ,0 0 1 .3

S h a r e s O u t. ( M M ) : 2 3 ,9 4 7 .0

F lo a t ( M M ) : 5 ,9 0 8 .6

A v g . D a ily V o l. : 5 3 ,6 9 8 ,7 8 0 .0

Price Performance

Source: Bloomberg

7

7.5

8

8.5

9

9.5

10

10.5


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21 November 2016



The Art of Chinese Regulation The regulatory environment mis-perceived to be stable

The stocks of China Mobile, China Telecom and China Unicom have been widely followed

by institutional investors and sell-side analysts. The consensus view seems to be generally

positive because valuation is “cheap” and the regulatory environment is “stable.” To

come up with a proper long-term view on these three stocks, we believe it is key to

examine the history of regulatory development in China, which will provide a sound basis

to predict where policy focus will be moving toward`. Historically, government policies

have had a significant influence on the operators’ profitability. Therefore, this exercise

could be more critical than analysis of revenue and cost on a quarterly basis.

Telecom has always been a regulated industry anywhere in the world, because spectrum

is a public resource and telephony services are considered a basic necessity. Government

policies do affect telecom operators’ profitability because they drive, for example, the

number of licenses (players) in the market, technology standards (neutral in most

markets), and how to create a level playing field for new entrants. In most countries, the

telecom regulator is pro-competition and pro-consumers.

The situation in China is, however, special because while China would like to create some

competition in the telecom industry, it has been more pre-occupied with its desire to

maintain absolute control over it, since it is a highly strategic industry and key to national

security. Therefore, telecom policies in China have always been a struggle to balance

investment needs, consumer benefits, operators’ profitability and other national priorities

from time to time (eg, the telecom equipment industry). At different times in the past, the

government has tended to stress one or two aspects over the others. To complicate

matters, various factions with vested interests tend to pressure the government or

telecom regulator to shift its policies in their favor.

In order for the government to maintain control over the industry, all three operators

(there were four at one time) continue to be majority state-owned, even though they are

publicly listed. That has several consequences: 1) the management are effectively civil

servants, who will do their best in maximizing efficiency but only within the overall

constraints imposed by the government, 2) these operators will have to accommodate

government objectives even if some objectives may not be the best commercial decisions,

and 3) the government may be interested in boosting their profitability, only if no other

more important priorities are present that conflict with that.

Need to look at regulatory history to

assess future direction

The regulator in China is far more

than just being pro-consumers

The government retains absolute

control over this strategic industry;

regulations aim to achieve a range of

objectives

All 3 operators are majority state-

owned; management always

accommodate government priorities

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Chart 11: A Summary of China’s Telecom Regulatory Development since the

First Privatization


Month Year Major regulatory and corporate events Our interpretation of the government's policy focus

<1993

Telecom services were monopolized by China Telecom Group,

which belonged to the Ministry of Post and Telecoms

Jun 1994

State Council approved the creation of Unicom to provide

competition in the telecoms industry. Later China Jitong and China

Netcom were given licenses to operate data and Internet services.

China Railcom was allowed to provide all telecoms services other

than cellular.

1995

Unicom started using the structure of China-China-Foreign

ventures to build GSM networks in different cities and a

nationwide data and long distance network.

1997

China Telecom (Hong Kong) Ltd. (which has become the China

Mobile today) was established and raised US$4.2bn in an IPO. It

owned the parent's mobile operatios in two provinces (ie,

Guangdong and Zhejiang)

1998 State Council allowed Unicom to offer nationwide cellular services.

Feb 1999

Cellular services were split off from China Telecom Group. China

Mobile Communications Corp. was created to own all cellular

businesses previously owned by China Telecom Corp. China

Telecom Corp became a nationwide fixed line operator.

1999

MII approved the transfer of China Telecom's paging business to

Unicom. Unicom was authorized by the State Council to build a

nationwide CDMA network.

June 2000

China Uniom raised US$5.65bn in an IPO. Its parent started

building the CDMA network and leased capacity to the listco.

China Telecom (Hong Kong) Ltd. Changed its name to China

Mobile (Hong Kong) Ltd.

Dec 2001

China joined WTO. State Council promulgated Administrative

Regulations on Telecommunications Companies with Foreign

Investment to gradually reduce barriers for foreign investors to

enter China's telecoms industry.

May 2002

China Telecom, which operated China's nationwide fixed line

network, was split into north and south. China Netcom was formed

to take over northern operations of China Telecoms (10 provinces

in the northern part of China)

Nov 2002

China Telecom raised US$1.7bn in an IPO, initially with fixed line

operations in Shanghai, Guangdong, Jiangsu and Zhejiang.

Nov 2004

Management re-shuffle: CEO of China Mobile became CEO of

China Telecom, China Telecom's CEO became CEO of Unicom, and

Unicom's CEO became China Mobile's CEO

Nov 2004 China Netcom raised US$1.15bn in an IPO

Mar 2008

The MII was restructured to become the Ministry of Industry and

Information Technology (MIIT). The MIIT is responsible for

overseeing telecoms, Internet, broadcasting, telecoms equipment,

electronics and software industries.

Oct 2008

Unicom sold its CDMA biz to CT, and merged with China Netcom.

The merged company stays with the name China Unicom.

Dec 2008

The State Council gave go-ahead to the MIIT starting the process

of preparing for the issue of 3G license with a special objective to

support the TD-SCDMA standard.

Jan 2009

Unicom awarded a 3G license based on WCDMA technology; CT

awarded a 3G license based on CDMA2000 technology; China

Mobile was awarded a 3G license based on TD-SCDMA. China

Mobile's parent took on the job to build the TD-SCDMA network

and lease capacity to the listco.

Dec 2013

CM, CT and Unicom each awarded a 4G license based on TD-LTE

technology. CM immediately started building out the 4G network

at the listco level.

Jan 2014

MIIT lowered mobile interconnection rate CT/Unicom pay to CM to

Rmb0.06/min to 0.04/min; while that for CM to CT/Unicom traffic

remains at Rmb0.06/min

July 2014

All 3 operators entered into an agreement to set up China Tower

Corporation by contributing the majority of their existing towers to

that company.

Feb 2015

CT and Unicom each awarded a 4G license based on FDD-LTE

technology

May 2015

CT and Unicom started offering mobile users to roll over their

unused mobile data to the following month, under government

pressure to lower Internet prices.

Jun 2015

The three operators started phasing out domestic roaming and

national long distance charges (by introducing one-rate packages).

Aug 2015

Management re-shuffle: Shang Bing, Vice Minister of the MIIT,

became Chairman of China Mobile; CEO of China Telecom became

Unicom's CEO, Unicom's CEO (Chang Xiao Bing) became China

Telecom's CEO (but Chang was arrested a few months later for

corruption and China Telecom's President & COO was made CEO)

Oct 2015

China Mobile started offering mobile users to roll over their unused

mobile data to the following month.

Nov 2015

China Tower Corp. was officially established, which will centralize

telecoms tower maintenance and capex in the future. The

shareholding of CM, CT and Unicom in China Tower is 38%, 27.9%

and 28.1%, respectively.

Nov 2015 China Mobile acquired China Tie Tong (China Railcom)

2016-2020

Forecast

Expect no change to industry structure. Prepare for

commercialization of mobile 5G technology by 2020. Introduce

Private-Public Partnership at the parent of Unicom and CT to help

these two weaker players with funding and management

resources.

Support government's Internet+ and Made in

China 2025 strategic goals by encouraging A) faster

coverage expansion, B) continued drop in tariffs,

and C) ongoing technology upgrade.

1) Continued efforts to eliminate corruption and

promote rational competition at the three telcos, 2)

Premier Li Keqiang called for more affordable and

widely available Internet access, and a more

advanced digital system

Prepared for China's first privatization of major state-

owned industries. A key pilot project for China.

State Council and Ministry of Post and Telecoms

probably disagreed on how much competition

should be allowed ahead of this major act.

Ministry of Information Industry (Ministry of Post

and Telecoms prior to 1998) focused on creating an

attractive equity story for China Mobile to raise

equity and acquire remaining assets from its parent.

Rapid network expansion to accommodate rising

demand for mobile services, and to pre-empt

possible entry of foreign competition. State Council

probably more supportive of Unicom.

1) Restructured China Telecom to give China

Netcom a piece of the pie, and prepared them for

IPOs, 2) Commercialized China-developed TD-

SCDMA as one of the three global 3G standards,

and 3) Eliminated corruption and promoted more

rational competition at the three telcos.

1) Promoted TD-SCDMA 3G standard - China

Mobile had pulled away from Unicom so much that

it was asked to do the national service. 2) Created a

more sustainable industry structure by restructuring

CT and Unicom into two integrated operators.

1) Promoted buildout of 4G, 2) less biased toward

TD since TD-LTE and FDD-LTE can converge, 3) a

more balanced industry structure means no more

restructuring, but with ongoing tweaks of policies

to give some help to CT and Unicom (eg,

establishment of the Tower Co).

This table may be too hard to read,

but it outlines how the government

has engineered the industry’s

transformation since its first

privatization in 1997

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Chart 1 outlines the historical development of regulatory changes and industry

restructuring in China’s telecoms industry since 1997, when the first privatization took

place. Our observations and conclusions are as follows:

1. Between 1995 and 2002 – Privatization and fund raising was the

focus. The government had focused on creating an attractive equity story for

the telcos so that they could raise money in the equity markets. The IPOs

achieved a few objectives for China: A) modernize management and improve

governance/efficiency, B) raise funds to rapidly roll out networks and improve

services (this was part of China’s modernization programs and they also helped

pre-empt competition from foreign entrants after China’s WTO entry), and C)

serve as a successful pilot program for China to privatize SOEs in other key

sectors in a similar fashion.

2. Between 2002 and 2008 – The Ministry of Information Industry (MII)

started acting more like an independent regulator, as the financial

ownership of the Chinese telcos had been transferred to the Ministry of Finance.

The regulatory focus was mainly on A) creating a more balanced and thus

sustainable industry structure, and B) developing 3G plans for China, with a

particular bias toward supporting the China-developed TD-SCDMA 3G standard.

On the other hand, with value-added and 2.5G services having taken off for

cellular operators both globally and in China, China Mobile had pulled away

from Unicom and the two fixed line operators. The result was that the

government decided to A) ask China Mobile to build a nationwide 3G network

based on TD-SCDMA to support the local equipment industry, and B)

restructure China Telecom, China Netcom and Unicom into two integrated

operators so they could compete effectively with China Mobile.

3. Between 2009 and 2015 – We characterized this period as the “heavy

investment” period for Chinese telcos. In 2008 the MII was restructured to

become the Ministry of Industry and Information Technology (MIIT). The MIIT’s

mandate is to oversee not just telecoms, but broadcasting, Internet, software,

telecom equipment and, effectively, the overall “knowledge economy” of China.

From this point and on, the policy focus on telecoms is not just supporting

telecoms, but related industries such as equipment and Internet. There has been

no more industry restructuring for telecom. The results are A) the issue of a 3G

license to China Mobile based on TD-SCDMA, B) the issue of a TD-LTE 4G license

to China Mobile and both TD-LTE and FDD-LTE 4G licenses to China Telecom

and Unicom, C) explicit and implicit pressure on the telecom operators to lower

data pricing (eg, data rollover in November 2015) to promote mobile Internet,

and D) the creation of a tower company to share maintenance cost and future

capex of tower construction, to lessen burden on the telecom operators.

For the next five years, we believe the policy focus will shift toward:

• More pressure for telecom operators to lower pricing on mobile data and

broadband services

• More pressure for operators to quickly expand 4G and broadband coverage

• Active R&D work and preparation for 5G technology, with a possible launch in

2019/20

• Ongoing efforts by telecom operators to upgrade data speed on both their

mobile and fixed line networks.

• Maintaining current structure of the telecom industry, but giving them some

help if the obligations prove to be too much to bear (there is no sign this is

necessary in the near term).

Between 1995 and 2002, three state-

owned telecom operators have all

been partially privatized and listed in

international stock markets

Between 2002 and 2008, the focus

was on issuing 3G licenses and

supporting the China-developed TD-

SCDMA standard

After 2009, the focus was on 3G

rollout and 4G licensing. The new

regulator, MIIT, oversees the entire

“knowledge economy” of China.

Over the next five years, the focus is

likely on 1) pushing for wide

coverage, 2) lower prices, 3)

ongoing tech upgrade, and 4)

preparing for 5G standard and

licensing

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Our prediction of China’s regulatory focus on telecom is mainly driven by China’s two key

strategic initiatives: Internet Plus and Made in China 2025. China is in the midst of trying

to upgrade its manufacturing industry. It wants to transform itself from a “big industrial

country” to a “powerful industrial country.” It believes the rapid upgrade and

applications of broadband, mobile Internet, big data and cloud computing will 1) help

improve the efficiency of traditional industries, 2) create new businesses and business

models of various industries (eg, Internet finance), and 3) when combined with

manufacturing, speed up the transition from low value-add to high value-add through

innovations. We believe the two initiatives will work tightly together to achieve the

government’s long-term goal to transform China’s economy.

Premier Li Keqiang, who is in charge of China’s economic policies, has repeatedly said that

China would need more broadband coverage, higher data speed and more affordable

mobile Internet services in order to promote the use of the latest technology. The rise of

Alibaba, Tencent and Baidu in China has proven to the government that a better telecom

infrastructure could nurture a few entirely new industries.

Therefore, the government will likely continue to see telecom as a tool, or utility, to

achieve more important strategic goals for the economy. In this case, it will be hard to see

a policy focus allowing exciting returns to be achieved by the telecom operators.

Further Industry Consolidation not In

Sight Speculation about the merger of China Telecom and Unicom is misplaced

After three rounds of industry restructuring, we believe the government currently

considers the industry structure with three integrated operators as a sustainable one, at

least in the next few years. Between 2002 and 2008, China Mobile’s revenue share of the

industry had risen from 41.6% to 55.3%. More seriously, its EBITDA share of the industry

had skyrocketed from 44% to 58%. We believe that prompted the MII to merge China

Netcom with Unicom, and have Unicom sell the CDMA network to China Telecom in

2008 to create more effective competition for China Mobile. At the same time, China

Mobile was awarded a fixed line license and, subsequently, it took over China Tietong

(known as China Railcom) to expand into fixed line and broadband services.

Chart 12: Revenue Shares of Chinese Telcos


The key objective is to support the

“Internet+” and “Made in China

2025” initatives

Telecom is now the tool China uses

to upgrade the economy

Speculation about the merger of CT

and Unicom is unfounded

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21 November 2016



Chart 13: EBITDA Shares of Chinese Telcos


Since the restructuring in 2008, China Mobile’s revenue share has in fact risen slightly

from 55% to 57%. Nevertheless, its EBITDA share has fallen by about 2 ppts. On the other

hand, the remaining revenue and EBITDA pies are now more evenly split between CT and

Unicom.

Given China Mobile’s natural advantage as the incumbent mobile operator and general

decline in fixed line voice services, it will be difficult to further reduce China Mobile’s

dominance by restructuring the industry, without having to break up China Mobile. But

even breaking up China Mobile regionally will not reduce its dominance in each province.

Therefore, as long as CT and Unicom are profitable enough to fund their capex, the

government will likely maintain the current industry structure. We believe a three-

operator market will allow the government to 1) offer enough choice to consumers, and

2) have adequate competition to drive down prices and faster network buildout. The

previous speculation about the potential merger between CT and Unicom is likely

unacceptable to the government because 1) it will offer too few choice to consumers, 2) it

may not create enough competition to achieve the government objectives of lower prices

and rapid technology upgrade, and 3) integrating the CDMA-based and GSM-based

mobile networks (even though they converge in 4G LTE) will be expensive and take time.

In the current market structure, we believe the government will ask China Mobile to “do

more” for the government given its significant lead in profitability and cash flow

generation. “Do more” will likely mean taking on more rapid 5G rollout and fixed line

broadband expansion to rural areas to support “Internet Plus” and “Made in China

2025.”

Will Capex Ever Fall? The light at the end of the tunnel may be a mirage

One of the investment negatives of Chinese telcos has been high capex. In the early

2000s, investors and most analysts generally believed that once the operators achieved

good network coverage, their capex to sales ratio would fall substantially. Discussions had

focused on whether the long-term capex to sales ratio could fall to the range of 10% to

15%. Mobile operators in developed markets had been able to achieve the high end of

that range.

Unfortunately, capex or the capex to sales ratio in China have not fallen as investors have

hoped for. Fixed line broadband expansion, transmission infrastructure upgrade, 3G

rollout (on three different standards) and then 4G rollout have kept capex at all operators

consistently high. The continued pursuit of network upgrade and China’s wide areas have

together driven China’s telecoms capex to sales ratio to more than double that in OECD

China Mobile’s natural dominance is

hard to weaken by further industry

structuring

A more practical solution is for the

government to keep asking CM to

do more

Capex to sales ratio has fallen in

developed markets, but not in China

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21 November 2016



countries. In absolute amount, total telecom capex as reported by the listed telecom

companies has gone up from Rmb150bn in 2006 to almost Rmb450bn in 2015.

Chart 14: Total Telecoms Capex in China

Source: Jefferies, company data Note: CDMA capex incurred by Unicom’s parent in 2006 and 2007, and TD-SCDMA capex incurred by China Mobile’s parent between 2009 and 2013 is excluded. CDMA capex incurred by China Telecom’s parent between 2008 and 2013 is included.

Chart 15: Telecoms Capex to Sales Ratio

Source: OECD Digital Economy Outlook 2015, company data, Jefferies Note: CDMA capex incurred by Unicom’s parent in 2006 and 2007, and TD-SCDMA capex incurred by China Mobile’s parent between 2009 and 2013 is excluded. CDMA capex incurred by China Telecom’s parent between 2008 and 2013 is included.

Since the CDMA capex borne by Unicom’s parent (2006 and 2007) and the TD-SCDMA

capex borne by China Mobile’s parent has never been reported, we did not include these

numbers in the total telecom capex calculations. We estimate that the unreported capex

would be in the range of Rmb150bn to Rmb200bn, which would push up the capex to

sales ratio to 36% over the past ten years.

For 2016, the capex budget of all three telecoms operators will fall versus 2015, driven by

1) already extensive buildout of 4G in tier-one and tier-two cities, 2) establishment of

China Tower Corp., which will take over future capex of tower construction, and 3)

cooperation efforts between CT and Unicom on facilities and base station sharing. In

total, the budgeted 2016 capex of the three operators will fall by 18.5% from the 2015

Telecom capex in China has risen 3x

in the past 10 years

China’s telecom capex to sales ratio

has been more than double that of

OECD countries as a whole

These high capex to sales ratios did

not even include unreported capex

on CDMA and TD-SCDMA

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Assuming Coverage

21 November 2016



level. However, the fall was mainly driven by the 44% fall at Unicom, which has

aggressively cut capex in 2G/3G, fixed line broadband network as well as infrastructure

and transmission.

Chart 16: Capex of Chinese Telcos: 2015 vs 2016 Budget (Rmb bn)

Source: company data, Jefferies

We agree that in the next two years the overall capex and capex to sales ratio in China will

likely fall moderately. However, to extrapolate that trend longer term and derive a DCF

valuation on the basis of a continued fall in absolute capex or the capex to sales ratio is

very risky.

As discussed in the first section of this report, we believe the policy focus in the next five

to seven years will be on pressing for faster network rollout and ongoing technology

upgrade. Therefore, the capex to sales ratio for the three Chinese telcos as a whole is

unlikely to be significantly below 30%. For China as a whole, we forecast total telecom

capex will rise slightly from Rmb1.2 trillion per year to Rmb1.3 trillion in the next four

years. The capex to sales ratio will stay roughly at 29%. Nevertheless, we believe it is

possible that the capex, as well as capex to sales ratio, starting from 2020 could rise

significantly above our current forecast should China decide to aggressively roll out 5G.

Chart 17: Total Capex Forecast and Capex to Sales Ratio Forecast

Source: company data, Jefferies

After aggressive 4G rollout, telecom

capex in China will likely fall

moderately in 2016

Longer term capex will go back up in

absolute terms

Capex to sales ratio will likely remain

closer to 30%

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21 November 2016



Continued Pressure to Lower Prices The government want lower and lower prices, to spur other industries

Competition has driven down telecom tariffs in China. However, the government has

from time to time given “indications” to telecom operators that they would like to see

faster fall in prices. Sometimes it is driven by consumer complaints; sometimes it is driven

by other priorities such as focusing on supporting the equipment industry.

Recently there have been strong signs that the telecom operators in China are under more

government pressure to cut prices:

• In June 2015, all three telecom operators introduced a data rollover

arrangement, where users can transfer unused mobile data in a particular month

to the following month.

• In mid-2016, CT and Unicom said they would phase out national roaming

charges (when a user makes or receives calls outside his/her home province) and

national long distance surcharges. China Mobile said in August 2016 that it

would start implementing a one-rate system for all local and national long

distance calls on its mobile networks.

• Premier Li Keqiang has said on several occasions that telecom pricing in China

needs to be more affordable to promote the popularity of mobile Internet and

mobile commerce.

The ongoing pressure for telecom operators to cut prices has caused China’s telecom

revenue to GDP ratio to continue falling in the past 10 years. In the early 2000s, many

analysts believed that telecom revenue would rise as a percentage of GDP as a country’s

income level increases. Therefore, the top line growth of Chinese telcos should continue

to exceed GDP growth. However, competition and government-led pressure to lower

prices from time to time have proved this theory wrong. It happened not only in China,

but also in India.

Chart 18: Telecom Revenue to GDP Ratio

Source: IMF World Economic Outlook 2015, www.dnaindia.com, company data, Jefferies

Using data in 2014 and 2015, we found that there is no longer any material correlation

between the level of GDP per capita and a country’s telecom revenue to GDP ratio.

Therefore, even if China’s GDP per capita is expected to rise further, China’s telecom

revenue to GDP ratio may continue to languish.

Government pressure to lower prices

sometimes is explicit, and sometimes

implicit

Both mobile voice and data pricing

has been the government’s target

Telecom revenue as a % of GDP was

thought to rise along with income

But in China it has been falling for

the past 10 years, as well as in India

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http://www.dnaindia.com/

Chart 19: Telecom Revenue to GDP Ratio vs. GDP per Capita

Source: IMF World Economic Outlook 2015, UK Ofcom International Report for 2014, Jefferies Note: Data for China, India and Korea are for 2015; others for 2014

Another bullish argument for top line growth is the rising penetration of 4G in China. By

the end of September, there were 677m of 4G mobile users in China, which accounted for

51% of total mobile users. The theory is that 4G users will spend more on mobile Internet

services and thus would help lift revenue growth for the three Chinese telcos. Globally

there is a positive, but weak, correlation between 4G penetration rate and the ratio of

telecom revenue to GDP. Nevertheless, China is significantly above the trend curve,

which means its telecom revenue to GDP ratio is much lower than its 4G penetration

would suggest. We believe it is because both voice and data prices in China are very low

and the continued pressure for the Chinese telcos to lower prices will likely keep its

telecom revenue to GDP ratio falling. In other words, telecom revenue in China will

continue to grow at a slower rate than the slowing GDP growth, in our view.

Chart 20: Telecom Revenue to GDP Ratio vs 4G Penetration


There is no clear relationship

between telecom revenue as a % of

GDP and income level any more

Some argue rising 4G penetration

will lift the telecom revenue to GDP

ratio

China’s 4G penetration is already

high but telecom revenue to GDP

ratio is still low

Telecommunications

Assuming Coverage

21 November 2016



Chart 21: Telecom Revenue to GDP Ratio – Global Comparison


Is Mobile Data Demand in China Price

Elastic? We give it benefit of the doubt now, but early signs suggest risk

Some optimism has been expressed that lower mobile data prices will stimulate enough

usage growth that it is in fact positive for the three Chinese telcos. We believe mobile data

demand is price elastic when prices are relatively high. At this point, in fact we are worried

that the price elasticity in China has been exhausted. Any further fall in mobile data

pricing is likely a negative development for the revenue growth of the Chinese telecom

operators.

Examining the general trend of mobile data pricing versus total mobile data traffic in

China may lead one to the conclusion that mobile data demand showed high elasticity of

demand. In 2015, average revenue per MB of mobile data fell by 41% YoY but total

mobile data traffic rose by 119%. In 1H16, mobile data pricing dropped another 43% YoY

while total mobile data traffic increased by 128%. On the surface, mobile data demand

looks very price elastic.

China’s low telecom revenue to GDP

ratio on a global basis is likely due to

low pricing

Mobile data demand should be price

elastic

Telecommunications

Assuming Coverage

21 November 2016



Chart 22: China’s Mobile Data Pricing vs Total Mobile Data Traffic – YoY

Change

Source: Company data, Jefferies

However, the total mobile data traffic growth has been a function of both organic usage

growth on the existing subscribers and new subscriber additions in 4G. The subscriber

growth was likely driven more by handset subsidies, promotion efforts and the general

need of faster data speed by consumers, rather than lower data pricing. We believe

examining the relationship between mobile data pricing and data of use (DOU) per 4G

subscriber will yield a more reliable estimate of price elasticity of demand for mobile data.

Using 1H16 data provided by CM and CT, we found that the elasticity of demand went

above -1, which means the percentage increase in DOU was smaller than the percentage

decrease in mobile data pricing. It is a significant cause of concern because if growth in

mobile data usage cannot offset the accelerating pricing pressure, revenue growth will

likely disappoint. That is also why we strongly believe China’s telecom industry revenue

growth will continue to lag GDP growth.

Chart 23: China Mobile’s Mobile Data Pricing vs DOU Per Subscriber – YoY

Change

Source: Company data, Jefferies Note: 2014 data reflect DOU per 3G subscriber, while data for 1H16 (vs 1H15) reflect DOU per 4G subscriber.

That seems to be supported by

examining total data traffic growth

vs. changes in data pricing

But total mobile data traffic growth is

driven by both subscriber growth

and organic usage growth

Focusing on organic growth of

mobile data traffic is more reliable,

and CM’s numbers in 1H16 suggest

some risk of that elasticity being

exhausted

Telecommunications

Assuming Coverage

21 November 2016



Chart 24: China Telecom’s Mobile Data Pricing vs DOU Per Subscriber – YoY

Change

Source: Company data, Jefferies Note: 2012-2014 data reflect DOU per 3G subscriber, while data for 1H16 (vs 1H15) reflect DOU per 4G subscriber.

Low Morale Makes Improvement Even

Harder Compensation pressure and lack of stock options increase execution risks

In the first section, we discussed extensively why we think the current regulatory

environment is shareholder unfriendly. Those regulatory factors are specific to the telecom

industry. Outside of that, we also believe there are more general government policies that

are not helping minority shareholders.

Under President Xi’s leadership, the Chinese government started implementing an

aggressive anti-graft campaign in 2013, and it is still ongoing. The anti-grafting campaign

has two parts: A) investigate, arrest and prosecute corrupted government officials

(regardless of ranks, including SOE management), and B) promote frugality at all levels of

government and SOEs.

The anti-graft campaign has stormed through all major industries. In telecom, a number

of senior management members of China Mobile and China Telecom have been arrested

(and fired) for corruption. What is worse, the pursuit of frugality has resulted in both pay

freeze and pay cut at all three telecom operators.

In 2015, the total compensation of all three telecom operators’ top management has

fallen by 25% to 73%. Some may argue that this is only to create an impression that they

support the government’s initiative. However, we believe it has had real negative impact

on the level of compensation at middle management, especially at the provincial level.

Even though there has been generally no pay cut for middle management, it becomes

much more difficult for top management to justify salary increases and/or bonuses for

middle management. Consequently, the telecom operators’ middle management are

effectively having a compensation freeze.

CT’s numbers in 1H16 also suggest

the same risk

Government’s focus on frugality

means a very tight budget for SOEs

Several senior executives in the

telecom industry arrested for

corruption

The top management of all three

operators took significant pay cuts

Telecommunications

Assuming Coverage

21 November 2016



Chart 25: Compensation Cut in 2015 vs 2014


Moreover, since 2013, the government has banned the issue of stock options to SOE

employees. Even for previously issued options that remain outstanding, SOE management

has been expected not to exercise them. Therefore, with no stock options and little

prospect of improving salaries and bonuses, we believe the morale of the telecom

operators’ senior and middle management is currently quite low. This is in stark contrast

with the situation in the early 2000s, when the newly created SASAC decided to

incentivize SOE management to improve efficiency by giving them stock options, and

using profitability and return on capital as the major criteria for evaluating the

performance of SOEs’ top management.

Given the competitive nature of China’s telecom industry, both senior and middle

management of the telecom operators have many KPIs to meet. Therefore, their jobs are

stressful but there is little financial upside for them. The resulting low morale will make

any operational improvement at these companies even harder to achieve, and may even

eventually cause an exodus of young talents to private companies.

Our Valuation Work Suggests

Significant Downside Continued pricing pressure means slowing revenue growth

In 2H2015, the three operators introduced a data rollover program, which allows

customers to transfer the used mobile data in their packages to the following month. This

resulted in a significant slowdown in mobile revenue growth last year. In fact, both CT

and Unicom registered negative revenue growth in 2015. With a very low base in

2H2015, we forecast revenue growth will recover in 2016 for all three operators.

However, we believe the revenue growth rate in 2016 is not sustainable simply because

the government continued to put pressure on different fronts.

Mobile data pricing continued to fall at a rate of 30%+ in 1H2016. Competition was a

factor but the ongoing steep cut was partly done to satisfy what was perceived as

government expectation. In addition, in CM started phasing out national roaming charges

and domestic long distance rate premiums by introducing nationwide one-rate packages.

We believe aggressive, pro-active cuts in mobile data pricing, elimination of domestic

roaming and long distance price premium, and rising popularity of over-the-top services

such as WeChat calls will continue to pressure revenue growth at all three operators.

2014A 2015A YoY 2014A 2015A YoY 2014A 2015A YoY

CEO 1,994 574.9 -71% CEO 911 670 -26% CEO 1,076 696 -35%

CFO 1,812 521.5 -71% COO 807 593 -27% CFO 1,013 676 -33%

Exec Director 1 1,812 498.1 -73% Exec Director 1 808 608 -25% Exec Director 1 902 610 -32%

Exec Director 2 1,812 498.1 -73% Exec Director 2 815 601 -26% Exec Director 2 866 610 -30%

Exec Director 3 796 589 -26%

China Mobile China Telecom China Unicom

Top management lead by example

There are no stock options any more

Middle management under a lot of

pressure but not financially

incentivized enough

Data rollover in 1H15 only the start

of further pricing pressure

Mobile data pricing continued to fall

by 30%+ YoY after the data rollover

in1H15

Telecommunications

Assuming Coverage

21 November 2016



Chart 26: YoY Growth in Service Revenue


Our view that there will be no industry consolidation in sight means that the degree of

competition in the industry will not materially improve. Even though CT and Unicom

entered into an agreement to share some base stations, and China Tower Corp. was

created to centralize the maintenance and construction of towers, we believe price

competition on mobile voice, mobile data and wireline broadband will continue to be

intense, owing to limited differentiation of services. The three operators have rationally

cut back handset subsidies as a way to stimulate subscriber growth and upgrade. While

we believe handset subsidies will likely be restrained, general marketing and promotional

costs and network operations cost will likely continue to rise, pressuring the operators’

EBITDA margin.

Chart 27: EBITDA Margin Trend


Established telecom companies are usually valued on the basis of discounted cash flow

(DCF), because the business is relatively stable (ie, non-cyclical) but has high capital

intensity. However, DCF’s major weakness is its high dependence on a few assumptions,

such as the weighted average cost of capital (WACC), the terminal growth rate and, in

case of telecoms companies, the long-term assumptions on capex. A small change in any

of these assumptions can swing the DCF results widely.

Chart 15 shows the summary results of our DCF valuation, which we also used as the

basis to set our target prices. We believe the most important assumption here is the capex

to sales ratio. Some analysts have derived a high DCF value for these three companies

Elimination of DLD price premium

and domestic roaming charges, and

further OTT substitution mean

further revenue growth pressure

No industry consolidation means a

moderate degree of price

competition will continue

We expect the EBITDA margin of all

three operators to fall more

We use DCF to value these

companies to capture their high

capex

But our assumption of capex to sales

at 27% to 30% is likely higher than

consensus

Telecommunications

Assuming Coverage

21 November 2016



because the capex to sales ratio is assumed to fall quickly in the future. We have argued

above the telecoms capex in China will likely remain high, driven by the government’s

pressure to constantly expand coverage and upgrade technology and data speed. We

expect these three companies will start building 5G mobile networks by the end of 2019,

which will kick off another “up cycle” in capex. Therefore, the long-term average capex to

sales ratio for these companies will very likely be near 30%. We believe any valuation

using a capex to sales ratio of 25% or below will turn out to be way too optimistic.

Chart 28: Summary of Our DCF Valuation


Chart 29: Summary of Unleveraged FCF Forecasts


Our DCF values, which are also our target prices for the three telecom operators, translate

into downside risk of 20%, 18% and 17% for Unicom, CM and CT, respectively. The DCF

values imply 3.7x, 3.0x and 2.9x 2017 EV/EBITDA for the three companies, respectively.

These implied EBITDA multiples may look low but in fact the continued high capex figures

at these operators could justify why their multiples should be low.

CM CT Unicom

WACC 7.8% 8.0% 5.1%

Terminal FCF growth 3% 6% 2%

Terminal EV/EBITDA 3.0 3.5 3.5

Capex to sales 30% 27% 30%

DCF value per share (HK$) 69.24 3.02 7.26

Current stock price (HK$) 84.6 3.65 9.07

Potential downside -18.2% -17.3% -19.9%

TP implied valuation

TP-implied 2017 EV/EBITDA 3.0 2.9 3.7

TP-implied 2017 P/E 10.8 10.4 -213.2

TP-implied 2017 P/B 1.2 0.65 0.69

TP-implied 2017 dividend yield 4.2% 3.4% 3.1%

China Mobile

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 257,485 273,467 283,309 275,286 269,524



Capex (186,000) (196,332) (209,574) (211,907) (215,499)

Unleveraged FCF 65,441 51,749 41,048 61,161 35,883

China Telecom

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 98,134 102,804 106,706 107,400 106,781



Capex (97,000) (95,500) (95,632) (93,174) (94,246)

Unleveraged FCF 7,986 1,039 1,944 8,214 7,197

China Unicom

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 81,593 79,736 87,685 88,701 88,141



Capex (75,000) (73,920) (76,247) (77,289) (78,377)

Unleveraged FCF (7,625) 11,768 19,047 17,693 9,399

Our DCF-based TPs imply 17% to

20% downside to their stock prices

CT’s free cash flow will be under the

most pressure in the next two years

Our TPs do not translate into

unreasonable EV/EBITDA multiples

Telecommunications

Assuming Coverage

21 November 2016



At our target price, CM will trade at an estimated dividend yield of 4.2%, which is an

attractive level and so may provide some downside protection. However, it is still not

extremely cheap. For CT and Unicom, their implied dividend yields at our target prices are

3.3% and 2.9%, respectively, which would not be viewed as extremely attractive. Since

we believe both CT and Unicom have limited capacity to raise its dividend payout, we

believe dividend yield may not provide a very strong downside protection for the prices of

these two stocks.

Chart 30: DCF Valuation Sensitivities to Capex to Sales Ratio Assumptions in

Year 2020 (HK$/share)


We provide a sensitivity analysis of our DCF valuation to the assumptions of capex to sales

ratio in Chart 20. It shows the DCF result is highly sensitive to a change in the capex to

sales ratio (in the terminal year). Therefore, one can always come up with a high DCF

value by assuming a lower capex to sales ratio (or vice versa). Furthermore, our sensitivity

analysis indicates that China Telecom’s DCF value is the most sensitive to this particular

assumption. Therefore, if one disagrees with our negative view on the capex outlook,

China Telecom is the stock to buy.

Even though DCF is normally the appropriate methodology to value telecoms companies,

we would like to highlight the following risks of using DCF for these three Chinese

operators:

1) Minority shareholders have no control over the use of these operators’ FCF

2) History has shown, and we forecast it will continue to be the case, that

management is reluctant to pay out FCF to shareholders, in order to preserve

funds for future investments.

3) For China Telecom, we forecast its FCF generation will be unable to support a

higher dividend payment, even if it wants to.

4) These companies are not for sale; nor are they subject to any M&A, since they

are SOEs in a highly strategic industry

Consequently, we believe there is a risk that, even though somewhat remote now, the

market may start valuing these companies using the dividend discount model (DDM),

since each company does pay a dividend. We have attempted the exercise of coming up

with a DDM valuation estimate for each of the companies in the following. This is not

being used as our base case, but it helps illustrate what the downside risk could be in a

more extreme case.

Around July and August this year, there was a lot of talk about China’s intention to ask

SOEs to raise their dividend payment so that the government can collect more money for

fiscal spending. Even if we are not entirely convinced this will happen, we have built in a

15% increase in dividend per share for 2016 for all three companies in our DDM

calculations.

CM CT Unicom

+2% 55.3 -0.8 0.4

+1% 62.2 1.1 3.7

Base case 69.2 3.0 7.3

-1% 75.8 5.0 10.5

-2% 82.70 6.9 13.8

-3% 89.5 8.8 17.2

Neither do they translate into

unreasonably high dividend yields

This table shows the DCF sensitivity

to our assumption of capex to sales

ratio in 2020

CM’s DCF is the least sensitive to our

capex to sales assumption; CT’s is

the most sensitive

Do investors really have control over

their FCF?

Further downside could come if the

market starts using DDM to value

these stocks

There is hope that dividends will rise

Telecommunications

Assuming Coverage

21 November 2016



Chart 31: China Mobile’s Dividend Payment History


Chart 32: China Telecom’s Dividend Payment History


Chart 33: China Unicom’s Dividend Payment History


We are not so sure, given the track

record of these companies

CT’s dividend payout ratio has been

falling

Unicom had to cut dividends back in

2010 because of heavy capex and

high leverage

Telecommunications

Assuming Coverage

21 November 2016



In terms of the ability to raise dividends, China Mobile is the strongest because it is the

only one that is in a net cash position. Historically the three Chinese telcos have been

trying to maintain a stable dividend payment, even though in some years the dividend

payment exceeded their FCF. We forecast that the dividend payment at China Mobile and

China Telecom will continue to exceed their FCF generation in the next four years. For

China Unicom, except for 2016, we forecast that their FCF generation will well cover their

dividend payment. However, since both China Telecom and China Unicom are quite

highly geared, we believe China Mobile is the only company, among the three, that is not

financially constrained to significantly raise their dividend payment.

Chart 34: China Mobile’s Dividend vs FCF


Chart 35: China Telecom’s Dividend vs FCF


FCF generation is likely a more

important driver for dividend

decisions

CM’s dividend payment generally

matches its FCF. But we forecast it

will exceed its FCF in the next two

years, assuming a 15% rise this year

We forecast negative FCF at CT in the

next two years, so any dividend

increase is a tall order

Telecommunications

Assuming Coverage

21 November 2016



Chart 36: China Unicom’s Dividend vs FCF


Chart 37: Financial Leverage Comparison


We believe, therefore, China Mobile is under the most pressure from investors to raise its

dividend payout. However, from management’s perspective, it is likely that they will want

to preserve a lot of cash for future capex, especially given the high possibility that they will

be asked to do national services from time to time (eg, build out of TD-SCDMA based 3G

network).

Since the dividend payout ratio of all three companies is low, it is not surprising that the

DDM valuation turns out low relative to their current stock prices. However, if this is the

only way that minority shareholders can share these companies’ FCF, the market may

ultimately trade these stocks on their DDM value.

Even if Unicom’s FCF is forecast to

exceed its dividends, high gearing

will likely discourage management

to hike divdiends

High financial leverage at CT and

Unicom

CM under the most pressure from

investors to pay up

The DDM valuation is low because of

low dividends

Telecommunications

Assuming Coverage

21 November 2016



Chart 38: Summary of DDM Valuation


On September 28, China’s National Development and Reform Commission (NDRC)

included China Unicom as one of the SOEs that will participate in a private-public

partnership (PPP) pilot project. Although no specific information is available, the objective

of PPP is generally understood to promote the participation and investment of private

businesses in SOEs. It has created some excitement for China Unicom’s stock price owing

to speculation that large private Internet companies in China such as Baidu, Alibaba and

Tencent may be interested in taking a stake.

At the moment, we do not believe any of the Chinese Internet companies will be keen to

invest in China Unicom, mainly because 1) the big difference in corporate culture will

make integration very difficult, and 2) there are some synergies but none of the Internet

companies would like to risk alienating itself from the other two telecoms operators,

which have more extensive network infrastructure.

On the other hand, it is of course possible that, despite the “commercial considerations”

mentioned above, the private Internet companies in China may still want to do so if they

perceive it as a “favor” to be done to the government. However, we believe that even if

such an investment will take place, it will likely be a minority stake in the parent company,

so any real impact on China Unicom’s operations will take years to realize.

We believe the main catalysts for the de-rating will be:

1) Continued high capex guidance for 2017, which will be announced in

March/April 2017

2) No dividend increase in the upcoming result announcements (March/April

2017). For China Mobile, even a special dividend or a small increase in its payout

ratio will be considered disappointing.

3) Continued weak EBITDA and net profit growth as shown by quarterly reports in

the next three to four quarters.

2015A 2016E 2015A 2016E 2015A 2016E

DPS (Rmb) 2.21 2.54 0.08 0.09 0.17 0.20

Growth 15.0% 15.0% 15.0%

HK$/Rmb 1.14 1.14 1.14

LT dividend growth rate

High 5.0% 5.0% 5.0%

Base 2.5% 2.5% 2.5%

Low 0.5% 0.5% 0.5%

Discount rate 7.8% 9.6% 8.3%

DDM per share Rmb HK$

Current stock

price HK$ Rmb HK$

Current stock

price HK$ Rmb HK$

Current stock

price HK$

High 95.23 108.74 84.60 2.03 2.31 3.65 6.14 7.01 9.07

Base 49.08 56.04 84.60 1.28 1.46 3.65 3.43 3.92 9.07

Low 34.93 39.89 84.60 0.98 1.12 3.65 2.51 2.86 9.07

China Mobile China Telecom China Unicom

Inclusion of Unicom in the PPP pilot

project raised the hope that Chinese

Internet firms may invest in Unicom

Even if it happens, the impact on

Unicom’s operations and thus

profitability will be limited

We expect 3 catalysts for the de-

rating process

Telecommunications

Assuming Coverage

21 November 2016



China Mobile (941 HK) The least risky of the three

China Mobile’s (CM) strong incumbent position and significant net cash

position makes it the least risky stock to own among the three. Owing to its

natural incumbent advantage, its mobile revenue market share has stayed

roughly the same at 67% since 2014. The convergence of TDD and FDD in 4G

has helped CM retain high-end subscribers. CM’s Rmb420bn net cash will be

enough to cushion any unexpected hikes in capex owing to occasional

national services. Its DCF value is also the least sensitive to any further rise (or

fall) in capex.

Entrenched market position as an incumbent CM’s incumbent status and strong government support from the beginning gives it a

significant lead in indoor and outdoor coverage, economies of scale and bargaining

power against equipment vendors. The lack of mobile number portability also allows CM

to retain most of the high-end users. In 2009, it was awarded a 3G license based on the

China-developed TD-SCDMA standard. It was asked to aggressively roll out the network in

order to help create and foster the value chain from chipsets to network equipment and

handsets. Since the handset choice was limited and the standard is not globally

compatible, China Mobile has suffered. Its subscriber market share fell from 72% in 2010

to 64% in 2014, while its revenue market share slipped even more, from 79% to 67%.

However, CM’s competitive disadvantage was reversed with the issue of a 4G license in

2014 based on TDD-LTE technology. Since TDD and FDD technology can converge in a

4G LTE network (can share the same core network), a wide range of dual-mode, multi-

band handsets have been developed. China Mobile’s users can use these handsets to

roam on FDD 4G networks outside of China. Moreover, they do not have to buy another

handset if they decide to switch to CT or Unicom (many Chinese users use two networks

because they have two numbers). Therefore, China Mobile’s subscriber and revenue

market share started stabilizing. Since 2014, its revenue market share has remained at

about 67%.

A strong balance sheet allows rapid network build CM’s significant balance sheet strength is the major reason that it could rapidly build a 4G

TDD network with good coverage so as to arrest its market share decline. Since it was

awarded a 4G license in December 2013, it spent Rmb80bn setting up 720,000 4G base

stations in 2014. The number of 4G base stations further increased to 1.2m in 2015,

versus 400K at Unicom and 520K at CT. The rapid network buildout helped CM retain

high-end users, and encouraged its existing 3G users to upgrade to 4G handsets.

By the end of 2015, CM already had 312m 4G users (38% of its user base), whereas CT

had only 58.5m (30%) and Unicom has only 44m (18%). We believe CM’s entrenched

market position can repeat its impressive performance when China starts building out 5G

networks in 2019/2020. In our forecast, CM’s mobile revenue market share will stay

roughly at 68% over the next four years.

Risk of asymmetric regulations is not all gone Expect asymmetric measures to “take advantage of” CM’s dominance

We do not believe there will be further industry restructuring in China’s telecoms sector,

mainly because it is difficult to reduce CM’s incumbent dominance simply by reshuffling

assets. The idea of merging CT and Unicom is unlikely to be on the table, since 1)

combining the two mobile networks (one is CDMA based and the other is GSM based)

will not make it more competitive with CM, 2) a two-operator market does not give

consumers enough choice (from both the government’s and consumer’s perspective),

and 3) integrating the two companies will be a big challenge, especially if we assume

there will be no staff reductions.

The least risk of the three owing to its

Rmb420bn net cash on the balance

sheet

55.0%

60.0%

65.0%

70.0%

75.0%

80.0%

85.0%

2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

China Mobile's Subscriber and Revenue

Market Shares

Subscriber market share Revenue market share

Convergence of TDD and FDD in 4G

helped CM stabilize market share

410

720

940

1,100

1,320

120

320

510

610

850

399

588

680

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

1H14 2H14 1H15 2H15 1H16 2H16E

Number of 4G Base Stations

CM CT Unicom

Our forecast of no industry

consolidation does not mean no

government action to try reducing

CM’s dominance

Source: Company data, Jefferies estimates

Source: Company data

Telecommunications

Assuming Coverage

21 November 2016



However, we believe CM’s continued dominance as shown by our forecast revenue

market shares will longer term pose a challenge to the regulator. The better CM does

financially versus CT and Unicom, the higher the risks of further asymmetric regulations.

We believe the MIIT has a few tools under consideration: 1) further asymmetric

interconnection rate changes – this is simple to do and we in fact forecast another one

coming in 2018, 2) asymmetric mobile number portability (ie, users can move their

phone numbers from CM to CT or Unicom, but not vice versa) – this is technically more

difficult to implement and the impact is also less certain, and 3) administrative measures

that ask CM to do more national services, such as aggressively rolling out 5G early to spur

growth in the industry value chain.

Therefore, even though CM is financially the strongest operator, it faces the highest

regulatory risks, which makes its stock’s outlook unattractive.

Dividend to exceed FCF; any big hike unlikely Three reasons why a much higher dividend payout ratio is unlikely

There is a lot of pressure from financial investors for CM to raise its dividend payment.

Expectations are high among sell-side analysts as well. A few months ago there was

speculation that the government may be asking SOEs to raise their dividend payment so

that the government can collect more money for fiscal spending. That also helped fuel the

expectations. However, we are taking a less optimistic view.

First, we do not know for sure whether the government is seriously asking SOEs to

upstream their earnings. Even though SOEs are all owned by the government, there could

be many layers between the SOEs and the Ministry of Finance. How much of that

“upstreaming” is leaked in the process is a big question mark. Another source of leakage

is the minority shareholders. For example, CM is 25% owned by financial investors

(mostly foreign) - does the government want a 25% direct leakage by asking CM to raise

its dividends? It may think that by keeping the cash at CM, the government or country

may benefit more by “directing” CM how to use that cash.

Second, management of SOEs do not seem to have the motivation to pay out a lot of their

FCF as dividends. Telecom is a capital intensive industry. Management would rather retain

the cash in case they need to invest in network expansion, new technologies, and/or

marketing campaigns. Raising capital is hard work in the eyes of management, and now

they are not financially motivated to make dividend increase a top priority.

Third, CM’s FCF has fallen significantly over the past three years owing to high capex and

pricing as well as margin pressure. Over the next three years, we forecast that its FCF will

unlikely recover, and, consequently, our projected dividend payment (incorporating a

one-off 15% increase in 2016) will exceed its FCF in 2017 and 2018. This is another reason

why we believe management is unlikely to commit to any longer-term increase in the

payout ratio.

Valuation looks cheap but likely a value trap CM is currently trading at 4.3x EV/EBITDA and 13.6x PE for 2016. On an ex cash basis its

PE multiple will fall to roughly 10x. While the valuation multiples look inexpensive,

because we forecast no EBITDA growth and an earnings decline over the next few years,

its multiples in fact will rise.

CM’s current stock price implies a P/B multiple of 1.5x and EV/IC multiple of 2.0x for

2016, versus its ROAE of 11.7% and ROIC of 17%. We estimated CM’s cost of equity at

7.8%. Therefore, its current ROAE is 1.5x of its cost of equity, which makes its P/B multiple

of 1.6x not particularly cheap. Since CM has no debt, we assumed that its WACC is the

same as its cost of equity. In other words, its ROIC is about 2.2x its WACC, which is similar

to its EV/IC multiple of 2.0x, again suggesting that CM’s current valuation is not

particularly cheap.

Regulatory tools include

interconnect rebalance, asymmetric

MNP and administrative measures

Pressure from financial investors to

raise dividends

The government may not want a

higher dividend

Management’s motivation to raise

dividends is also limited

CM’s dividend is forecast to exceed

its FCF in the next two years

CM’s earnings multiples look low,

but there is no growth

1.5 1.5

2.0 2.2

-

0.5

1.0

1.5

2.0

2.5

2016 P/B ROAE/CoE 2016 EV/IC ROIC/WACC

China Mobile's P/B and EV/IC

Telecommunications

Assuming Coverage

21 November 2016



Since one of our biggest concerns is capex, we set our target price of HK$69.24 on the

basis of our DCF estimate. Our DCF valuation is based on a WACC of 7.8% and a terminal

growth rate (of unleveraged FCF) of 3%. The 3% terminal growth rate translates into an

EV/EBITDA multiple of 3.0x. At our target price of HK$69.24, CM will be trading at 3.0x

EV/EBITDA, 10.6x P/E, 1.2x P/B and 4.2% dividend yield for 2017. The 4.2% dividend yield

has incorporated our assumption that CM will raise its dividend per share by 15% in 2016.

If it does not do so, the dividend yield will be below 4%. We believe these DCF-implied

multiples are not unreasonable.

Chart 39: China Mobile’s Valuation Summary


Chart 40: China Mobile’s Income Statement

Dec. 31, Rmb m 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Voice services 343,985 364,189 368,025 355,686 313,476 261,896 229,924 197,555 169,693 146,815 130,623

Data services 120,768 139,330 166,348 206,886 258,462 303,425 390,592 460,120 508,976 539,034 566,585

Wireless data 30,644 44,428 68,257 108,239 153,926 200,857 280,968 342,845 387,561 414,848 439,749

SMS & MMS 46,889 46,462 44,215 41,320 34,780 31,244 29,663 26,761 21,945 15,843 10,636

Applications & info

services

43,235 48,440 53,876 57,327 53,552 52,985 53,937 54,735 54,825 54,797 54,780

Wireline broadband 0 0 0 0 16,204 18,339 26,025 35,779 44,645 53,546 61,421

Other service

revenue

20,478 33,469 35,149 37,852 19,664 18,768 18,768 19,331 19,911 20,508 21,124

Sale of products

and others

7,512 10,298 21,484 39,624 59,907 84,246 80,166 92,209 70,906 87,333 67,093

Total service

revenue

485,231 536,988 569,522 600,424 591,602 584,089 639,284 677,006 698,580 706,357 718,332

Total revenue 492,743 547,286 591,006 640,048 651,509 668,335 719,450 769,215 769,486 793,690 785,424

Opex

Leased lines &

network assets

3,897 6,358 8,597 14,816 15,843 20,668 45,099 46,717 48,372 51,466 55,493

Interconnection 21,886 23,638 25,156 25,983 23,502 21,668 21,418 20,545 19,633 18,473 17,858

Personnel 24,524 52,548 59,499 66,681 70,385 74,805 77,797 81,298 84,550 87,594 90,397

Selling exp. 74,361 78,556 79,987 91,719 75,655 59,850 59,391 61,571 58,424 58,559 56,844

Costs of products

sold

20,506 23,124 41,497 61,409 74,495 89,297 87,811 102,826 81,761 95,815 75,939

Other operating

expenses

108,249 111,251 119,923 136,523 151,504 162,293 170,650 182,993 193,640 206,699 219,571

Total opex 253,423 295,475 334,659 397,131 411,384 428,581 462,167 495,950 486,379 518,606 516,102

EBITDA 239,320 251,811 256,347 242,917 240,125 239,754 257,283 273,265 283,107 275,084 269,322

EBITDA margin 48.6% 46.0% 43.4% 38.0% 36.9% 35.9% 35.8% 35.5% 36.8% 34.7% 34.3%

D&A 86,292 101,120 106,072 111,571 122,917 137,106 136,325 149,843 165,089 182,242 196,998

Operating profit 153,028 150,691 150,275 131,346 117,208 102,648 120,959 123,422 118,018 92,842 72,324

Dec 31, Rmb m 2014A 2015A 2016E 2017E 2018E 2019E

Revenue 651,509 668,335 719,450 769,215 769,486 793,690

EBITDA 240,237 240,028 257,485 273,467 283,309 275,286

vs concensus 0.7% 0.5%

Net profit 109,218 108,539 111,521 114,799 111,832 93,078

Basic EPS (Rmb) 5.38 5.30 5.45 5.61 5.46 4.55

vs concensus 3.0% -2.3%

EPS growth -7.4% -1.5% 2.7% 2.9% -2.6% -16.8%

PE 13.8 14.0 13.6 13.2 13.6 16.3

EV/EBITDA 4.6 4.6 4.3 4.0 3.9 4.0

ROAE 13.0% 12.0% 11.7% 11.4% 10.4% 8.3%

ROIC 21.3% 15.7% 17.0% 16.9% 15.4% 11.3%

Dividend yield 3.1% 3.0% 3.42% 3.42% 3.42% 3.42%

P/B 1.7 1.6 1.5 1.5 1.4 1.3

EV/IC 2.6 2.2 2.0 2.0 1.9 1.8

FCF yield to market cap 2.8% 4.1% 3.9% 3.0% 2.2% 3.6%

CM’s ROIC and ROE are forecast to

fall


Telecommunications

Assuming Coverage

21 November 2016



Chart 40: China Mobile’s Income Statement


Finance costs 902 1,232 949 1,195 487 455 220 220 220 220 220

Interest income 5,658 8,447 12,696 15,368 16,270 15,852 16,000 17,000 18,000 18,000 18,000

Other income 1,225 4,904 6,357 8,052 9,419 25,415 9,950 10,800 11,300 11,800 12,100

Pretax income 159,071 162,864 168,793 153,649 142,522 143,734 146,891 151,204 147,300 122,624 102,406

Income tax 39,047 40,593 41,887 36,746 33,179 35,079 35,254 36,289 35,352 29,430 24,578

Net income 120,024 122,271 126,906 116,903 109,343 108,655 111,637 114,915 111,948 93,194 77,829

Non-controlling

interests

384 109 107 112 125 116 116 116 116 116 116

Profit attributable

to shareholders

119,640 122,162 126,799 116,791 109,218 108,539 111,521 114,799 111,832 93,078 77,713

Basic EPS (Rmb) 5.96 6.09 6.31 5.81 5.38 5.30 5.45 5.61 5.46 4.55 3.80

WA shares O/S (m) 20,063 20,068 20,091 20,101 20,293 20,473 20,475 20,475 20,475 20,475 20,475

DPS (Rmb) 2.60 2.73 2.77 2.62 2.31 2.21 2.54 2.54 2.54 2.54 2.54

Dividend payout

ratio

44% 45% 44% 45% 43% 42% 47% 45% 47% 56% 67%

YoY Change(%)

Voice services 5.9% 1.1% -3.4% -11.9% -16.5% -12.2% -14.1% -14.1% -13.5% -11.0%

Data services 15.4% 19.4% 24.4% 24.9% 17.4% 28.7% 17.8% 10.6% 5.9% 5.1%

Wireless data 45.0% 53.6% 58.6% 42.2% 30.5% 39.9% 22.0% 13.0% 7.0% 6.0%

SMS & MMS -0.9% -4.8% -6.5% -15.8% -10.2% -5.1% -9.8% -18.0% -27.8% -32.9%

Applications & info

services

12.0% 11.2% 6.4% -6.6% -1.1% 1.8% 1.5% 0.2% -0.1% 0.0%

Wireline broadband 13.2% 41.9% 37.5% 24.8% 19.9% 14.7%

Other service

revenue

63.4% 5.0% 7.7% -48.1% -4.6% 0.0% 3.0% 3.0% 3.0% 3.0%

Sale of products

and others

37.1% 108.6% 84.4% 51.2% 40.6% -4.8% 15.0% -23.1% 23.2% -23.2%

Total service

revenue

10.7% 6.1% 5.4% -1.5% -1.3% 9.4% 5.9% 3.2% 1.1% 1.7%

Total revenue 11.1% 8.0% 8.3% 1.8% 2.6% 7.6% 6.9% 0.0% 3.1% -1.0%

Opex

Leased lines &

network assets

63.2% 35.2% 72.3% 6.9% 30.5% 118.2% 3.6% 3.5% 6.4% 7.8%

Interconnection 8.0% 6.4% 3.3% -9.5% -7.8% -1.2% -4.1% -4.4% -5.9% -3.3%

Personnel 114.3% 13.2% 12.1% 5.6% 6.3% 4.0% 4.5% 4.0% 3.6% 3.2%

Selling exp. 5.6% 1.8% 14.7% -17.5% -20.9% -0.8% 3.7% -5.1% 0.2% -2.9%

Costs of products

sold

12.8% 79.5% 48.0% 21.3% 19.9% -1.7% 17.1% -20.5% 17.2% -20.7%

Other operating

expenses

2.8% 7.8% 13.8% 11.0% 7.1% 5.1% 7.2% 5.8% 6.7% 6.2%

Total opex 16.6% 13.3% 18.7% 3.6% 4.2% 7.8% 7.3% -1.9% 6.6% -0.5%

EBITDA 5.2% 1.8% -5.2% -1.1% -0.2% 7.3% 6.2% 3.6% -2.8% -2.1%

EBITDA margin -2.6% -2.6% -5.5% -1.1% -1.0% -0.1% -0.2% 1.3% -2.1% -0.4%

D&A 17.2% 4.9% 5.2% 10.2% 11.5% -0.6% 9.9% 10.2% 10.4% 8.1%

Operating profit -1.5% -0.3% -12.6% -10.8% -12.4% 17.8% 2.0% -4.4% -21.3% -22.1%

Pretax income 2.4% 3.6% -9.0% -7.2% 0.9% 2.2% 2.9% -2.6% -16.8% -16.5%

Income tax 4.0% 3.2% -12.3% -9.7% 5.7% 0.5% 2.9% -2.6% -16.8% -16.5%

Net income 1.9% 3.8% -7.9% -6.5% -0.6% 2.7% 2.9% -2.6% -16.8% -16.5%

Non-controlling

interests

-71.6% -1.8% 4.7% 11.6% -7.2% 0.0% 0.0% 0.0% 0.0% 0.0%

Profit attributable

to shareholders

2.1% 3.8% -7.9% -6.5% -0.6% 2.7% 2.9% -2.6% -16.8% -16.5%

Basic EPS (Rmb) 2.1% 3.7% -7.9% -7.4% -1.5% 2.7% 2.9% -2.6% -16.8% -16.5%

DPS (Rmb) 5.2% 1.6% -5.5% -11.8% -4.6% 15.0% 0.0% 0.0% 0.0% 0.0%


Telecommunications

Assuming Coverage

21 November 2016



Chart 41: China Mobile’s Balance Sheet


Chart 42: China Mobile’s Cash Flow Statement


Dec 31, Rmb m 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Current assets

Cash and bank deposits 292,346 332,978 402,903 419,908 428,055 403,187 426,312 493,038 492,966 512,887 507,458

Cash and cash equivalents 87,543 86,259 70,906 44,931 73,812 79,842 102,967 169,693 169,621 189,542 184,113

Short-term bank deposits 204,803 246,687 331,997 374,977 353,507 323,330 323,330 323,330 323,330 323,330 323,330

Restricted deposits 0 32 0 0 736 15 15 15 15 15 15

Inventories 4,249 7,944 7,195 9,152 9,292 9,994 9,659 11,311 8,994 10,540 8,353

Accounts receivables 14,658 28,648 20,327 25,556 31,282 43,929 46,028 47,390 45,408 42,381 43,100

Prepayments 10,151 12,854 15,913 11,832 15,482 11,427 11,427 11,427 11,427 11,427 11,427

Other current assets 428 261 255 741 2,814 20,160 20,160 20,160 20,160 20,160 20,160

Total current assets 321,832 382,685 446,593 467,189 486,925 488,697 513,587 583,327 578,955 597,395 590,498

Non-current assets

PPE and construction in progress 440,164 464,400 486,016 564,227 700,133 673,643 723,318 769,807 814,292 843,958 862,460

Lease payments 12,040 12,798 14,244 19,735 24,883 26,773 26,773 26,773 26,773 26,773 26,773

Goodwill and intangibles 37,707 37,712 37,818 37,957 36,130 36,111 36,111 36,111 36,111 36,111 36,111

Interest in associates/JVs 40,183 43,801 48,349 53,940 70,451 115,933 125,333 136,133 147,433 159,233 171,333

Receivables from tower asset sale 0 0 0 0 0 56,737 56,737 0 0 0 0

Other current assets 10,009 11,162 19,089 24,344 29,513 30,001 30,001 30,001 30,001 30,001 30,001

Total non-current assets 540,103 569,873 605,516 700,203 861,110 939,198 998,273 998,825 1,054,610 1,096,076 1,126,678

Total assets 861,935 952,558 1,052,109 1,167,392 1,348,035 1,427,895 1,511,860 1,582,152 1,633,565 1,693,471 1,717,176

Current liabilities

Short-term debt and bills payable 5,483 1,616 1,159 1,360 1,674 645 645 645 645 645 645

Current portion of deferred revenue 43,557 51,821 58,056 61,857 63,984 78,100 78,100 78,100 78,100 78,100 78,100

Accounts payable 111,646 116,266 123,896 173,157 227,577 243,579 254,192 272,773 267,508 285,234 283,856

Accrued expenses and other payables 85,766 92,680 103,829 125,833 153,225 170,680 184,867 173,583 170,233 171,140 170,314

Tax payable 9,178 10,861 10,856 8,706 6,032 8,034 8,034 8,034 8,034 8,034 8,034

Total current liabilities 255,630 273,244 297,796 370,913 452,492 501,038 525,837 533,134 524,520 543,153 540,949

Non-current liabilities

Long-term debt 28,615 28,617 28,619 4,989 4,992 4,995 4,995 4,995 4,995 4,995 4,995

Other non-current liabilities 287 278 385 766 1,568 1,494 1,494 1,494 1,494 1,494 1,494

Total non-current liabilities 28,902 28,895 29,004 5,755 6,560 6,489 6,489 6,489 6,489 6,489 6,489

Shareholders' equity 577,403 650,419 725,309 790,724 888,983 920,368 979,534 1,042,529 1,102,556 1,143,830 1,169,738

Total liabilities and shareholders' equity861,935 952,558 1,052,109 1,167,392 1,348,035 1,427,895 1,511,860 1,582,152 1,633,565 1,693,471 1,717,176


Cash flow from operations

EBITDA 247,136 261,321 261,902 248,801 251,700 255,132 257,485 273,467 283,309 275,286 269,524

Change in working capital 23,111 5,513 13,390 19,406 3,794 17,751 23,035 4,283 (4,314) 20,113 (736)

Income tax paid (38,868) (40,078) (44,583) (43,222) (39,056) (37,794) (35,254) (36,289) (35,352) (29,430) (24,578)

Net cash flow from operations 231,379 226,756 230,709 224,985 216,438 235,089 245,266 241,461 243,643 265,969 244,211

Cash flow from investing

Capex (113,203) (123,331) (123,232) (138,997) (174,673) (172,243) (186,000) (196,332) (209,574) (211,907) (215,499)

Acquisition (disposal) of assets or interests in associates(39,637) 140 0 (1,363) (9,508) (376) 0 56,737 0 0 0

Others (18,732) (46,165) (67,944) (31,115) 32,951 29,876 16,000 17,000 18,000 18,000 18,000

Net cash flow from investing (171,572) (169,356) (191,176) (171,475) (151,230) (142,743) (170,000) (122,595) (191,574) (193,907) (197,499)

Cash flow from financing

Interest paid (919) (651) (403) (329) (480) (442) (220) (220) (220) (220) (220)

Dividend paid (50,201) (52,575) (55,425) (55,512) (50,934) (47,933) (51,921) (51,921) (51,921) (51,921) (51,921)

Others 69 (5,194) 931 (23,590) 8,884 (38,135) 0 0 0 0 0

Net cash flow from financing (51,051) (58,420) (54,897) (79,431) (42,530) (86,510) (52,141) (52,141) (52,141) (52,141) (52,141)

Net change in cash 8,756 (1,020) (15,364) (25,921) 22,678 5,836 23,125 66,726 (72) 19,921 (5,429)

Effect of changes in forex rate (107) (264) 11 (54) (46) 194 0 0 0 0 0

Beg balance 78,894 87,543 86,259 70,906 51,180 73,812 79,842 102,967 169,693 169,621 189,542

Ending balance 87,543 86,259 70,906 44,931 73,812 79,842 102,967 169,693 169,621 189,542 184,113

Telecommunications

Assuming Coverage

21 November 2016



Chart 43: China Mobile’s Major Operating Expenses Assumptions


Chart 44: China Mobile’s Fixed Asset Schedule


31-Dec 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Maintenance cost as a % of GBV of PPE 4.3% 4.0% 4.1% 3.8% 3.8% 3.7% 3.7% 3.7%

Operating lease charges as a % of GBV of PPE 1.4% 1.3% 1.5% 1.4% 1.3% 1.3% 1.3% 1.3%

YoY growth of Others 9.3% 6.4% 5.5% 4.3% 3.0% 3.0% 2.5%

YoY growth in personnel costs 12.1% 5.6% 6.3% 4.0% 4.5% 4.0% 3.6% 3.2%

Interconnection cost per min (Rmb) 0.0060 0.0055 0.0051 0.0052 0.0051 0.0050 0.0049 0.0049

Selling expenses

Fixed marketing and promotions expense (Rmb m) 60,000 55,000 50,000 48,000 53,000 53,000 55,000 55,000

Variable selling expense per net add (Rmb) 438 355 323 325 350 400 400 400

Leased tower cost (Rmb m) - - 5,600 32,000 34,517 36,572 40,166 44,193

Other leased line expense (Rmb m) 14,816 15,843 15,068 13,099 12,200 11,800 11,300 11,300

Effective tax rate 23.9% 23.3% 24.4% 24.0% 24.0% 24.0% 24.0% 24.0%

Rmb m 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Gross fixed assets

Beginning balance 710,267 803,204 874,088 959,220 1,073,173 1,235,055

Acquisition of China Railcom 0 0 0 0 81,441 84,932

Adjusted beginning balance 710,267 803,204 874,088 959,220 1,154,614 1,319,987 1,327,047 1,513,047 1,709,379 1,918,953 2,130,860

Additions/capex 114,247 125,986 126,022 155,597 209,674 195,145 186,000 196,332 209,574 211,907 215,499

Disposal/writeoff (21,310) (55,102) (40,890) (41,644) (44,301) (188,085) 0 0 0 0 0

Ending balance 803,204 874,088 959,220 1,073,173 1,319,987 1,327,047 1,513,047 1,709,379 1,918,953 2,130,860 2,346,360

Accumulated depr

Beg balance 350,192 417,908 465,923 528,711 593,946 670,260

Acquisition of China Railcom 0 0 0 0 40,097 44,704

Adjusted beginning balance 350,192 417,908 465,923 528,711 634,043 714,964 741,416 877,741 1,027,583 1,192,672 1,374,914

Increase in depr 86,230 97,113 100,853 104,736 122,844 136,858 136,325 149,843 165,089 182,242 196,998

Impairment and disposal (18,514) (49,098) (38,065) (39,501) (41,923) (110,406) 0 0 0 0 0

Ending balance 417,908 465,923 528,711 593,946 714,964 741,416 877,741 1,027,583 1,192,672 1,374,914 1,571,912

Net fixed assets

Beg balance 360,075 385,296 408,165 430,509 520,571 605,023 585,631 635,306 681,795 726,280 755,946

Ending balance 385,296 408,165 430,509 520,571 605,023 585,631 635,306 681,795 726,280 755,946 774,448

Capex assumptions (Rmb m) 186,000 196,332 209,574 211,907 215,499

Capex to service revenue 25.6% 25.1% 22.7% 31.7% 36.4% 33.5% 29.1% 29% 30% 30% 30%

Telecommunications

Assuming Coverage

21 November 2016



Chart 45: China Mobile’s DCF Valuation



Risk free rate 1.40% Terminal growth rate 3.2%

Equity risk premium 7.80% Terminal FCF x 21.8

Beta 0.82 Terminal value 805,720

CoE 7.8% Terminal EV/EBITDA 3.0

Cost of debt NA

After-tax cost of debt NA

WACC 7.8%

DCF Valuation (Rmb m) 2016E 2017E 2018E 2019E 2020E

EBITDA 257,485 273,467 283,309 275,286 269,524



Capex (186,000) (196,332) (209,574) (211,907) (215,499)

Unleveraged FCF 65,441 51,749 41,048 61,161 35,883



Discount factor 1.00 0.93 0.86 0.80 0.74

PV of unleveraged FCF 65,441 48,006 35,325 48,827 623,299


Less: net debt (end of 2016) (420,672)

Equity value (Rmb m) 1,241,572



TP Scenario Analysis Terminal Growth

69.2 2.2% 2.7% 3.2% 3.7% 4.2%

6.8% 70.4 74.7 80.3 87.7 97.9

7.3% 66.3 69.8 74.1 79.6 86.9

7.8% 63.0 65.8 69.2 73.5 78.9

8.3% 60.3 62.6 65.3 68.7 72.9

8.8% 57.9 59.8 62.1 64.8 68.2

WA

CC

Our DCF valuation yields a base-case

target price of HK$69.24 per share

Telecommunications

Assuming Coverage

21 November 2016



China Telecom (0728 HK) Most vulnerable to high capex

China Telecom (CT) became an integrated operator by buying the CDMA

business from China Unicom in 2008. Prior to that, it had been the incumbent

fixed line operator in 21 provinces of China, mainly in the south. It was

awarded a 4G license based on FDD-LTE technology in 2015. Since 2012, its

capex has doubled to Rmb109bn in 2015 because of broadband expansion

and 4G network rollout. We forecast its operating cash flow will decline

slightly in the next few years owing to margin pressure. If capex does not fall

in line, its FCF will turn negative and its dividend will be at risk. Our DCF value

implies 18% downside risk, but it is the most sensitive to future capex

assumptions among the three operators.

A large fixed line business has been a burden Prior to buying Unicom’s CDMA business in 2008, CT had been a pure fixed line operator

in 21 out of 31 provinces in China. As of 2010, revenue of fixed line voice accounted for as

much as 30% of its total service revenue. Owing to mobile substitution, CT’s revenue of

fixed line voice has fallen from Rmb62bn in 2010 to Rmb30bn in 2015. For its fixed line

business, growth in broadband access, internet data centres and corporate leased lines

has offset the decline in voice, resulting in flattish total revenue growth in the past five

years. Therefore, almost all the top line growth at CT has been coming from mobile.

Between 2010 and 2015, its mobile service revenue has grown 160%, from Rmb48bn to

Rmb124bn. However, the mobile revenue growth rate is set to slow because of 1)

continued competitive and government pressure to keep lowering both voice and data

prices, 2) over-the-top (OTT) substitution for mobile voice (eg, WeChat call), and 3)

already high penetration of 4G at 51% by September 2016.

Despite strong growth in its mobile revenue, CT’s fixed line revenue (Rmb169bn in 2015)

is still larger than that of mobile (Rmb125bn in 2015). We forecast that will remain the

case in the next four years, because the growth rate in both businesses is expected to be

in only low single-digit percentages.

Margin will unlikely improve As of 1H16, CT had a mobile subscriber market share of 15.9%, versus its revenue market

share of 15.1%. Back in 2012, its subscriber market share was 14.9% but its revenue

market share was low at only 11.8%. Therefore, CT has been able to catch up significantly

on the quality of its subscribers. The other reason is likely its efforts to improve network

coverage and increase data speed, which have helped boost usage of its existing users.

CT’s performance in mobile has been better than Unicom in that its revenue market share

is only 80 bps below its subscriber market share, whereas for Unicom it is 360 bps below.

However, the fact that neither CT nor Unicom has been able to achieve a higher revenue

market share than its subscriber market share shows CM’s strong entrenched market

position as the incumbent. We forecast that situation is not going to improve in the next

four years.

Given a very strong incumbent competitor in mobile and a large but inherently less

profitable fixed line business, CT’s EBITDA margin is the lowest among the three

operators. In 1H16, CT’s EBITDA margin was 28.6%, versus 29.4% for Unicom and 36.3%

for CM. We forecast that CT’s EBITDA margin will continue to be the lowest among the

three operators, and in fact it will fall slightly over the next four years driven by slowing

revenue growth but higher network and marketing costs.

IDC, ICT and IPTV are bright spots, but not enough Owing to the fast growth in mobile data applications, online commerce and adoption of

web-based IT technology for SMEs, CT has experienced significant growth in its data-

We forecast it will turn FCF negative.

Our TP implies 18% downside

62,499

49,770

43,369

38,633 33,587

29,610

20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

2010A 2011A 2012A 2013A 2014A 2015A

China Telecom's Fixed Line Voice

RevenueRmb mn

47,722

68,248

92,803

113,751 120,268

124,503

30,000

50,000

70,000

90,000

110,000

130,000

2010A 2011A 2012A 2013A 2014A 2015A

China Telecom's Mobile Service

Revenue

Rmb m

14.9% 15.4%14.7%

15.5% 15.9%

11.8%

13.5%14.3% 15.2% 15.1%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

2012A 2013A 2014A 2015A 1H16A

China Telecom's Mobile Performance


48.6%

35.9% 34.3%

34.4%

28.4% 27.6%

34.8%31.6%

29.8%

15.0%

25.0%

35.0%

45.0%

55.0%

CM CT Unicom




Telecommunications

Assuming Coverage

21 November 2016



related fixed line business. In particular, revenue from data centres (IDC) and information

systems integration (ICT) for SMEs has seen strong growth over the past three years.

In addition, CT has launched its own set top box to provide TV services over its broadband

network. By the end of 1H16, it has garnered approximately 50m users at a monthly ARPU

of around Rmb8. The current IPTV penetration of its broadband user base is about 42.5%,

and we forecast it will grow to close to 60% by the end of 2020.

Despite the impressive growth of these fixed line data services, they are not big enough in

absolute size to lift the growth of the overall fixed line service. In 2015, these three

services together contributed only 17.7% of total fixed line service revenue, up from

12.8% in 2013. We forecast the revenue from these three services together will grow at a

Cagr of 16% in the next four years. But the Cagr of the overall fixed line revenue is

forecast at only 3.4%.

FCF will be lower than forecast dividend payment In 2015, CT generated just enough FCF to pay dividends. For 2016, we forecast its FCF

will fall by Rmb2.0bn, and will be less than even the 2015 dividend payment. Since we

have assumed a 15% increase in DPS for all three operators in 2016, CT will have a

shortfall of Rmb2.3bn in 2017 (ie, dividend payment exceeds FCF by Rmb2.3bn).

Moreover, when CT bought the CDMA network from its parent in 2012, it has a deferred

consideration of Rmb61bn that is due in 2017. Based on the current FCF generation at CT,

we do not believe it will be able to meet that obligation.

The easiest way for CT to deal with that is to re-negotiate with its parent to further defer

that payment, probably at the same level of interest rate (3.5% to 4.5% pa). An alternative

is to seek bank financing or issue domestic bonds to pay off its parent. We believe CT is

unlikely to seek an external solution because re-negotiating it with its parent should be

the easiest and will give it maximum flexibility.

Furthermore, we forecast CT’s FCF will turn negative in 2018 and 2019, driven by our

assumptions of lower margin but still high capex. However, with its net debt to equity at

27% in 2016, we forecast it will be able to maintain our forecast DPS. But we think, as a

consequence, CT’s management will be very reluctant to increase its dividend even for

2016. In fact we would not rule out a dividend cut in 2018 or 2019.

DCF value highly sensitive to capex assumptions Since CT is forecast to generate negative FCF in 2018 and 2019, our DCF valuation

depends much more on the terminal value (in 2020) and the capex assumption in that

year. Our base-case capex assumption in 2020 is Rmb94bn, or 27% of service revenue.

Using a WACC of 8% (9.6% cost of equity and 3% after-tax cost of debt) and a terminal

FCF growth rate of 6% (translating into 3.5x EV/EBITDA), we derived a DCF value of

HK$3.02 per share.

For every one percentage point change in the capex to sales ratio in 2020, the DCF value

will move by roughly HK$1.90 per share. Therefore, CT’s DCF value is the most sensitive

to the terminal year’s capex to sales assumption among the three operators. If one

disagrees with our view on the capex outlook, CT should be the stock to buy.

CT is currently trading at 13.0x PE, 3.5x EV/EBITDA and 2.8% dividend yield for 2016.

Since we forecast little growth at both of its EBITDA and net profit, its PE and EV/EBITDA

multiples will fall only slightly in the next few years. Its 2016 P/B ratio is 0.81, against a

return on average equity (ROAE) of 6.4%. Its ROAE is 67% of its cost of equity, which

suggests its 0.81x P/B multiple is expensive. Furthermore, a similar comparison of CT’s

EV/IC multiple at 0.86x to its ROIC/WACC of 0.725 also indicates that the stock currently is

not cheap.

Its IPTV service has over 50m users

But Internet and data services were

only 17.7% of fixed line revenue

16,132

6,852

4,792

(2,390)(1,709)

4,210

2,789

6,198 6,160 7,165 7,165 7,165 7,165 7,165

(5,000)

0

5,000

10,000

15,000

2014A 2015A 2016E 2017E 2018E 2019E 2020E

CT's Free Cash Flow vs. Dividend Payment

FCF (Rmb m) Dividend payment (Rmb m)

It will also need to pay its parent

Rmb61bn in 2017 as a deferred

payment for its purchase of the

CDMA network

CT’s ability to raise dividends is

constrained

Our DCF valuation of HK$3.05 based

on a long-term capex to sales ratio of

27%, implies 17% downside

-0.8

1.1

3.0

5.0

6.9

8.8

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

29% 28% 27% 26% 25% 24%

CT's DCF Value Sensitvity to Capex to Sales

Ratio Assumption (HK$/share)

0.81

0.67

0.86

0.73

-

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00


China Telecom's P/B and EV/IC


Source Jefferies estimates

Telecommunications

Assuming Coverage

21 November 2016



Chart 46: China Telecom Valuation Summary


Chart 47: China Telecom’s Income Statement


Mobile service

revenue

47,722 68,248 92,803 113,751 120,268 124,503 139,572 146,364 150,259 149,966 149,564

Voice revenue 28,906 38,628 49,166 58,217 54,673 48,983 45,039 40,247 34,854 30,105 25,994

Handset data

access revenue

0 8,688 12,163 22,908 34,086 47,770 69,094 82,108 92,484 98,217 103,246

Other VAS

revenue

18,816 20,932 31,474 32,626 31,509 27,750 25,439 24,009 22,921 21,645 20,324

Wireline service

revenue

161,871 158,734 158,046 165,100 167,111 168,763 174,200 182,948 191,284 195,122 199,496

Voice revenue 62,499 49,770 43,369 38,633 33,587 29,610 25,988 22,969 20,555 18,487 16,238

Internet access

revenue

54,965 61,691 67,782 71,432 74,622 75,852 79,061 83,849 87,908 88,032 88,975

VAS & Integrated

info sys

28,312 29,788 30,720 34,274 38,047 42,035 47,417 54,021 60,354 65,771 71,079

Lease of telco

network resources

12,371 14,321 15,577 17,203 16,869 17,213 17,557 17,908 18,267 18,632 19,005

Others 3,200 3,200 3,400 3,558 3,986 4,053 4,177 4,200 4,200 4,200 4,200

Sales of

equipment or

terminals

10,304 18,086 29,524 42,733 37,015 37,936 44,715 44,144 41,964 40,985 37,453

Total service

revenue

209,593 226,982 258,315 278,851 287,379 293,266 313,771 329,312 341,543 345,088 349,059

Total revenue 219,897 245,068 280,373 321,584 324,394 331,202 358,486 373,456 383,507 386,073 386,512

Opex

SG&A 42,153 48,765 63,099 70,448 62,719 54,472 55,865 55,713 57,239 55,858 56,812

Network

operations and

support

47,493 52,940 65,979 53,102 68,651 81,240 96,081 104,479 110,310 113,972 116,277

Salaries 35,564 39,204 42,857 46,723 50,653 52,541 55,083 57,287 59,292 61,070 62,903

Interconnect &

Others

19,113 28,878 40,367 54,760 47,518 48,843 53,322 53,173 49,960 47,773 43,740

Total opex 144,323 169,787 212,302 225,033 229,541 237,096 260,352 270,651 276,801 278,673 279,732

EBITDA 75,574 75,281 68,071 96,551 94,853 94,106 98,134 102,804 106,706 107,400 106,781

Dec 31, Rmb m 2014A 2015A 2016E 2017E 2018E 2019E

Revenue 324,394 331,202 358,486 373,456 383,507 386,073

EBITDA 94,853 94,106 98,134 102,804 106,706 107,400

vs consensus 1.6% 0.8%

Net profit 17,680 20,054 19,856 20,525 20,576 19,284

Basic EPS (Rmb) 0.22 0.25 0.25 0.25 0.25 0.24

vs consensus 2.2% -6.1%

EPS growth 0.8% 13.4% -1.0% 3.4% 0.2% -6.3%

PE 14.6 12.9 13.0 12.6 12.6 13.4

EV/EBITDA 3.6 3.6 3.5 3.3 3.2 3.2

ROAE 6.2% 6.7% 6.4% 6.3% 6.1% 5.5%

ROIC 5.8% 5.2% 5.8% 5.6% 5.3% 4.8%

Dividend yield 2.4% 2.4% 2.8% 2.8% 2.8% 2.8%

P/B 0.89 0.85 0.81 0.78 0.75 0.73

EV/IC 0.92 0.90 0.86 0.82 0.78 0.75

FCF yield to market cap 6.2% 2.6% 1.9% -0.9% -0.7% 1.6%

Its ROIC is forecast to fall, and its PE

as well EV/EBITDA multiples will

unlikely fall

Telecommunications

Assuming Coverage

21 November 2016





EBITDA margin 34.4% 30.7% 24.3% 30.0% 29.2% 28.4% 27.4% 27.5% 27.8% 27.8% 27.6%

D&A 52,231 51,241 49,666 69,083 66,345 67,664 67,648 72,011 75,945 78,144 79,736

Operating profit 23,343 24,040 18,405 27,468 28,508 26,442 30,486 30,794 30,761 29,256 27,045

Net interest

income

3,601 2,254 1,562 5,153 5,291 4,273 4,200 4,300 4,500 4,900 5,400

Other income 459 139 171 773 40 4,524 60 700 1,000 1,200 1,300

Pretax income 20,201 21,925 17,014 23,088 23,257 26,693 26,346 27,194 27,261 25,556 22,945

Income tax 4,846 5,416 4,753 5,422 5,498 6,551 6,402 6,581 6,597 6,185 5,553

Net income 15,355 16,509 12,261 17,666 17,759 20,142 19,944 20,613 20,664 19,372 17,392

Non-controlling

interests

118 96 115 121 79 88 88 88 88 88 88

Profit attributable

to shareholders

15,237 16,413 12,146 17,545 17,680 20,054 19,856 20,525 20,576 19,284 17,304

Basic EPS (Rmb) 0.19 0.20 0.15 0.22 0.22 0.25 0.25 0.25 0.25 0.24 0.21

WA shares O/S (m) 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932

DPS (Rmb) 0.07 0.07 0.07 0.08 0.08 0.08 0.09 0.09 0.09 0.09 0.09

Dividend payout

ratio

39% 34% 46% 35% 34% 31% 36% 35% 35% 37% 41%

YoY

Mobile service

revenue

43.0% 36.0% 22.6% 5.7% 3.5% 12.1% 4.9% 2.7% -0.2% -0.3%

Voice revenue 33.6% 27.3% 18.4% -6.1% -10.4% -8.1% -10.6% -13.4% -13.6% -13.7%

Handset data

access revenue

n.a. 40.0% 88.3% 48.8% 40.1% 44.6% 18.8% 12.6% 6.2% 5.1%

Other VAS

revenue

11.2% 50.4% 3.7% -3.4% -11.9% -8.3% -5.6% -4.5% -5.6% -6.1%

Wireline service

revenue

-1.9% -0.4% 4.5% 1.2% 1.0% 3.2% 5.0% 4.6% 2.0% 2.2%

Voice revenue -20.4% -12.9% -10.9% -13.1% -11.8% -12.2% -11.6% -10.5% -10.1% -12.2%

Internet access

revenue

12.2% 9.9% 5.4% 4.5% 1.6% 4.2% 6.1% 4.8% 0.1% 1.1%

VAS & Integrated

info sys

5.2% 3.1% 11.6% 11.0% 10.5% 12.8% 13.9% 11.7% 9.0% 8.1%

Lease of telco

network resources

15.8% 8.8% 10.4% -1.9% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%

Others 0.0% 6.3% 4.6% 12.0% 1.7% 3.1% 0.6% 0.0% 0.0% 0.0%

Sales of

equipment or

terminals

75.5% 63.2% 44.7% -13.4% 2.5% 17.9% -1.3% -4.9% -2.3% -8.6%

Total service

revenue

8.3% 13.8% 7.9% 3.1% 2.0% 7.0% 5.0% 3.7% 1.0% 1.2%

Total revenue 11.4% 14.4% 14.7% 0.9% 2.1% 8.2% 4.2% 2.7% 0.7% 0.1%

Opex

SG&A 15.7% 29.4% 11.6% -11.0% -13.1% 2.6% -0.3% 2.7% -2.4% 1.7%

Network

operations and

support

11.5% 24.6% -19.5% 29.3% 18.3% 18.3% 8.7% 5.6% 3.3% 2.0%

Salaries 10.2% 9.3% 9.0% 8.4% 3.7% 4.8% 4.0% 3.5% 3.0% 3.0%

Telecommunications

Assuming Coverage

21 November 2016





Interconnect &

Others

51.1% 39.8% 35.7% -13.2% 2.8% 9.2% -0.3% -6.0% -4.4% -8.4%

Total opex 17.6% 25.0% 6.0% 2.0% 3.3% 9.8% 4.0% 2.3% 0.7% 0.4%

EBITDA -0.4% -9.6% 41.8% -1.8% -0.8% 4.3% 4.8% 3.8% 0.7% -0.6%

EBITDA margin -3.6% -6.4% 5.7% -0.8% -0.8% -1.0% 0.2% 0.3% 0.0% -0.2%

D&A -1.9% -3.1% 39.1% -4.0% 2.0% 0.0% 6.4% 5.5% 2.9% 2.0%

Operating profit 3.0% -23.4% 49.2% 3.8% -7.2% 15.3% 1.0% -0.1% -4.9% -7.6%

Net interest

income

-37.4% -30.7% 229.9% 2.7% -19.2% -1.7% 2.4% 4.7% 8.9% 10.2%

Other income -69.7% 23.0% 352.0% -94.8% 11210.0% -98.7% 1066.7% 42.9% 20.0% 8.3%

Pretax income 8.5% -22.4% 35.7% 0.7% 14.8% -1.3% 3.2% 0.2% -6.3% -10.2%

Income tax 11.8% -12.2% 14.1% 1.4% 19.2% -2.3% 2.8% 0.2% -6.3% -10.2%

Net income 7.5% -25.7% 44.1% 0.5% 13.4% -1.0% 3.4% 0.2% -6.3% -10.2%

Non-controlling

interests

-18.6% 19.8% 5.2% -34.7% 11.4% 0.0% 0.0% 0.0% 0.0% 0.0%

Profit attributable

to shareholders

7.7% -26.0% 44.5% 0.8% 13.4% -1.0% 3.4% 0.2% -6.3% -10.3%

Basic EPS (Rmb) 7.7% -26.0% 44.5% 0.8% 13.4% -1.0% 3.4% 0.2% -6.3% -10.3%

DPS (Rmb) -4.7% -0.9% 8.8% 0.0% 2.4% 15.0% 0.0% 0.0% 0.0% 0.0%


Telecommunications

Assuming Coverage

21 November 2016



Chart 48: China Telecome’s Balance Sheet


Chart 49: China Telecom’s Cash Flow Statement



Current Assets

Cash & cash equivalents 25,824 27,372 30,099 16,070 20,436 31,869 29,496 19,940 11,067 28,111 23,735

Inventories 3,170 4,843 5,928 6,523 4,225 6,281 6,707 6,622 6,295 6,148 5,618

Accounts receivable 17,328 18,471 18,782 20,022 21,562 21,105 16,923 17,592 17,992 18,114 18,183

Prepayments and others 8,923 8,895 10,566 10,168 13,320 18,853 20,849 22,111 23,107 23,524 23,604


Non-current assets

PPE 272,478 268,904 373,781 374,341 372,876 373,981 403,333 426,823 446,510 461,540 476,050

Construction in progress 14,445 18,448 32,500 44,157 53,181 69,103 69,103 69,103 69,103 69,103 69,103

Interest in associates and investments 1,977 1,633 1,632 2,132 5,078 36,097 36,157 36,857 37,857 39,057 40,357

Intangible, goodwill and other assets 76,384 70,585 72,003 69,826 70,596 72,272 72,272 72,272 72,272 72,272 72,272

Non-current assets 365,284 359,570 479,916 490,456 501,731 551,453 580,865 605,055 625,742 641,972 657,782

Total assets 420,529 419,151 545,291 543,239 561,274 629,561 654,839 671,320 684,202 717,869 728,922

Current liabilities

Short-term debt 31,027 20,953 16,735 47,759 44,058 51,720 51,720 51,720 51,720 51,720 51,720


Accrued expenses and other payables 52,885 59,375 105,781 69,633 72,442 82,934 88,520 89,315 88,576 89,175 89,514

Current portion of deferred revenues and others 2,972 2,575 2,146 1,574 1,367 3,220 3,220 3,220 3,220 3,220 3,220


Non-current liab

Long-term debt 42,549 31,150 83,070 62,617 62,494 64,830 64,830 64,830 64,830 84,830 84,830

Other non-current liabilities 4,933 3,829 2,511 1,860 2,347 4,051 4,051 4,051 4,051 4,051 4,051

Total non-current liabilities 47,482 34,979 85,581 64,477 64,841 68,881 68,881 68,881 68,881 88,881 88,881

Total liabilities 47,482 34,979 85,581 64,477 64,841 68,881 68,881 68,881 68,881 88,881 88,881

Equity

Share capital 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932 80,932

Retained earnings and minority interests 165,192 175,978 185,168 197,732 209,176 223,819 236,598 250,046 263,544 275,751 285,978

Total equity 246,124 256,910 266,100 278,664 290,108 304,751 317,530 330,978 344,476 356,683 366,910

Total liabilities and equity 420,529 419,151 545,291 543,239 561,274 629,561 654,839 671,320 684,202 717,869 728,922



EBITDA 77,056 74,387 70,292 97,634 99,375 98,108 98,134 102,804 106,706 107,400 106,781

Change in working capital 5,485 5,332 6,031 450 8,796 18,940 14,260 1,187 (1,685) 1,068 1,207

Income tax paid (3,448) (4,064) (4,011) (4,539) (6,407) (4,099) (6,402) (6,581) (6,597) (6,185) (5,553)

Net Interest paid (3,522) (2,646) (1,590) (5,194) (5,359) (4,199) (4,200) (4,300) (4,500) (4,900) (5,400)



Capex (41,597) (48,495) (50,071) (70,921) (80,273) (101,898) (97,000) (95,500) (95,632) (93,174) (94,246)

Proceeds from disposal 2,915 4,771 2,835 2,410 831 815 0 0 0 0 0

Acquisition of CDMA network from parent 0 0 0 (39,769) 0 0 0 0 0 0 0

Others

Net cash flow from investing (7,052) 87 (1,059) 332 (2,266) (1,167) 0 0 0 0 0

(45,734) (43,637) (48,295) (107,948) (81,708) (102,250) (97,000) (95,500) (95,632) (93,174) (94,246)


Proceeds from banks and other loans 53,518 23,876 9,702 54,983 53,022 67,875 0 0 0 20,000 0

Dividends paid (5,608) (6,174) (5,625) (5,433) (6,198) (6,160) (7,165) (7,165) (7,165) (7,165) (7,165)

Repayment of bank and other loans (86,001) (45,329) (24,133) (44,053) (56,819) (56,862) 0 0 0 0 0

Others (680) (96) 254 140 (332) (44) 0 0 0 0 0

Net cash flow from financing (38,771) (27,723) (19,802) 5,637 (10,327) 4,809 (7,165) (7,165) (7,165) 12,835 (7,165)

Net change in cash (8,934) 1,649 2,625 (13,960) 4,370 11,309 (2,373) (9,555) (8,874) 17,044 (4,376)

Effect of changes in forex rate (46) (101) (1) (69) (4) 124 0 0 0 0 0

Beg balance 34,804 25,824 27,475 30,099 16,070 20,436 31,869 29,496 19,940 11,067 28,111

Ending balance 25,824 27,372 30,099 16,070 20,436 31,869 29,496 19,940 11,067 28,111 23,735

Telecommunications

Assuming Coverage

21 November 2016



Chart 50: China Telecom’s Major Operating Expense Assumptions


Chart 51: China Telecom’s Fixed Asset Schedule



Handset subsidies (Rmb m) 12,114 15,641 21,754 22,795 15,340 11,620 11,270 10,313 11,139 9,758 10,812

Margin on fixed line equipment sales 28% 34% 32% 32% 31% 33% 33% 33% 33% 33%

Interconnection cost per minute (Rmb) 0.0231 0.0221 0.0223 0.0182 0.0185 0.0160 0.0160 0.0150 0.0140 0.0140

YoY change in salaries cost 10.2% 9.3% 9.0% 8.4% 3.7% 4.8% 4.0% 3.5% 3.0% 3.0%

Tower leasing cost (Rmb m) 0 0 0 0 2,700 15,500 19,375 21,313 23,018 24,168

Other network operations cost as a % of gross PPE 4.8% 5.7% 7.2% 8.3% 8.1% 7.8% 7.5% 7.1% 6.7%

Effective tax rate 24.0% 24.7% 27.9% 23.5% 23.6% 24.5% 24.3% 24.2% 24.2% 24.2% 24.2%

Dec 31 (Rmb m) 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Gross fixed assets

Beginning balance 735,924 765,225 910,589 959,617 947,338 946,323 1,043,323 1,138,823 1,234,455 1,327,629

CDMA network acquisition 0 102,873 0 0 0 0 0 0 0 0

Additions/capex 44,546 47,970 65,726 64,721 86,593 97,000 95,500 95,632 93,174 94,246

Tower asset sale 0 0 0 0 (32,988) 0 0 0 0 0

Disposal (15,245) (5,479) (16,698) (77,000) (54,620) 0 0 0 0 0

Ending balance 765,225 910,589 959,617 947,338 946,323 1,043,323 1,138,823 1,234,455 1,327,629 1,421,875

Accumulated depr

Beg balance 463,276 496,321 536,808 585,276 574,462 572,342 639,990 712,001 787,946 866,089

Increase in depr 46,903 45,321 63,864 62,688 63,856 67,648 72,011 75,945 78,144 79,736

Tower asset sale 0 0 0 0 (14,623) 0 0 0 0 0

Impairment and disposal (13,858) (4,834) (15,396) (73,502) (51,353) 0 0 0 0 0

Ending balance 496,321 536,808 585,276 574,462 572,342 639,990 712,001 787,946 866,089 945,825

Net fixed assets

Beg balance 272,514 268,904 373,781 374,341 372,876 373,981 403,333 426,823 446,510 461,540

Ending balance 268,904 373,781 374,341 372,876 373,981 403,333 426,823 446,510 461,540 476,050

Capex assumptions (Rmb m) 43,037 49,551 53,731 79,992 76,889 109,904 97,000 95,500 95,632 93,174 94,246

Capex to service revenue 32.8% 31.0% 28.1% 28.7% 26.8% 37.5% 30.9% 29.0% 28.0% 27.0% 27.0%

Telecommunications

Assuming Coverage

21 November 2016



Chart 52: China Telecom’s DCF Valuation




Equity risk premium 7.80% Terminal growth rate 6.1%





WACC 8.0%

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 98,134 102,804 106,706 107,400 106,781



Capex (97,000) (95,500) (95,632) (93,174) (94,246)

Unleveraged FCF 7,986 1,039 1,944 8,214 7,197



Discount factor 1.00 0.93 0.86 0.79 0.73

PV of unleveraged FCF 7,986 962 1,666 6,518 281,360







3.0 5.1% 5.6% 6.1% 6.6% 7.1%

7.0% 3.2 4.6 7.6 17.8 -92.1

7.5% 2.3 3.1 4.5 7.4 17.4

8.0% 1.7 2.2 3.0 4.4 7.3

8.5% 1.3 1.6 2.2 2.9 4.3

9.0% 1.0 1.2 1.6 2.1 2.9

WA

CC

Our DCF valuation is based on a

WACC of 8% and a terminal growth

rate of 6.1%, equivalent to 3.5x

EV/EBITDA

Telecommunications

Assuming Coverage

21 November 2016



China Unicom (0762 HK) A turnaround is possible but constrained by government policies

After it sold its CDMA business to CT and merged with China Netcom in 2008,

it has become an integrated operator with a single GSM-based mobile

network. Its fixed line operations are mainly in only the 10 provinces in the

north, Therefore, in mobile it has faced a tough challenge from CT since CT

could offer effective bundled services in the 21 southern provinces where it

dominates in the fixed line market. While Unicom’s net profit is meagre, we

forecast it will generate better FCF than CT because of a lighten burden on

fixed line. But it will also suffer from regulatory pressure to lower prices,

improve coverage and upgrade technology.

The new CEO could raise performance The new CEO brought a wealth of fixed line and mobile experience

In 2015 the government implemented another management reshuffle, in which CT’s CEO

became Unicom’s CEO. Unicom’s current CEO (Chairman Wang) had also been CM’s

CEO between 1999 and 2004. His track record at both CM and CT was outstanding. His

experience in running both the largest mobile and fixed line networks of the country

allowed him to quickly implement improvement initiatives at Unicom. Consequently,

Unicom delivered significantly better results in 1H2016 vs. 2H2015.

However, we believe the low-hanging fruits have been picked, and significant further

improvements may be more difficult. While Chairman Wang is highly capable, many

structural issues and deep-rooted practices of Unicom cannot be changed quickly just

because there is a new CEO. For example, the market was disappointed by its weak 3Q16

results, which showed an 88% QoQ decline in net profit. We believe the quality of

selected provincial management, performance evaluation system, equipment

procurement process and sales management all have issues that need to be addressed.

That will take time. Furthermore, we pointed out that the current lack of financial

incentives in the industry will make any performance improvement harder to achieve.

Mobile is still a big challenge There is significant structural weakness in Unicom’s mobile business because of its history.

It used to operate both a GSM network and CDMA network. Owing to a combination of

cannibalization worry and capital constraint, it had under-invested in the GSM network.

As a result, its subscriber base is of a much lower quality than CM’s. The situation

improved after it sold its CDMA business to CT in 2008. However, the network quality gap

takes a long time to narrow. After Chairman Wang joined, he significantly accelerated the

rollout of the 4G network, and reduced capex on 3G. However, an examination of

Unicom’s revenue market share shows that its market position in mobile has in fact

deteriorated in 1H16 versus 2015.

Although Unicom slightly improved its subscriber market share in 1H16, its revenue

market share fell by one percentage point, from 17.4% in 2015 to 16.4% in 1H16. In fact,

the gap between its subscriber and revenue market share in 1H16 (3.6 ppts) was the

largest since 2012. On the other hand, CT’s revenue market share in 1H16 was largely

stable versus 2015. Therefore, it indicates that Unicom is still fighting an uphill battle in

both increasing usage of the existing subscribers and signing up high-ARPU customers.

Fixed line is a smaller drag than at CT Before Unicom merged with China Netcom in 2008, its fixed line business was mainly to

provide domestic and international long distance call services. Since the merger with

Netcom, it inherited the incumbent fixed line operations in 10 provinces in the northern

region. Between 2010 and 2015, fixed line service revenue grew at a Cagr of 2.7%, which

is higher than 0.8% at CT. During this period, revenue from fixed line voice had fallen by

about Rmb20bn at Unicom, while the fall at CT was Rmb32bn. The fact that CT’s fixed

Significant challenge in mobile from

both CM and CT but smaller drag

from fixed line

25,377 25,087 23,785

13,253

19,982 21,302 20,420

6,016 5,905 4,315

(5,472)

1,210 2,158 919

-10,000

-5,000

-

5,000

10,000

15,000

20,000

25,000

30,000

1Q15A 2Q15A 3Q15A 4Q15A 1Q16A 2Q16A 3Q16A

China Unicom's quarterly EBITDA and Profit

EBITDA (Rmb m) Operating profit (Rmb m)

There are structural issues that could

take a long time to address

Unicom’s weak market position in

mobile is driven by historical reasons

19.2%20.7% 21.2%

19.8% 20.0%

16.0%17.9% 18.5%

17.4%16.4%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2012A 2013A 2014A 2015A 1H16A

China Unicom's Mobile Performance


34,520

28,710

24,375 21,844

18,336

14,797

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2010A 2011A 2012A 2013A 2014A 2015A

China Unicom's Fixed Line Voice

RevenueRmb m



Telecommunications

Assuming Coverage

21 November 2016



line business is in wealthier provinces could have resulted in a stronger mobile

substitution impact.

Similar to CT, the bright spots in the fixed line business are broadband, IDC and ICT

services. Owing to the rapid fall in fixed line voice revenue, Internet and Data (including

dial-up, broadband, IDC, cloud and managed data) and ICT together accounted for 67%

of fixed line service revenue in 2015. This revenue line is forecast to grow at a Cagr of

4.7% between 2015 and 2020. We forecast total fixed line service revenue will grow at a

Cagr of 3.8% during the same period.

In 2015, fixed line service revenue accounted for only 39% of total service revenue at

Unicom, versus 58% at CT. By 2020, we forecast the contribution of fixed line service

revenue at Unicom will rise to 42%, driven by our forecast of slower growth in mobile.

The fixed line revenue contribution at CT is forecast to stay largely the same by 2020.

Valuation unattractive on both DCF and multiples Our DCF value of HK$7.26 per share is based on a WACC assumption of 5.1% (cost of

equity of 8.3% and after-tax cost of debt of 2.6%) and a terminal growth rate of 2%,

implying a 3.5x EV/EBITDA multiple. Since Unicom is forecast to produce only meagre

profits in the next few years, a more reliable valuation multiple would be P/B and EV/IC.

It is currently trading at 0.86x P/B against the forecast return on average equity (ROAE) of

only 0.3% in 2016, which is only 3% of our cost of equity assumption. Therefore, this

valuation measure suggests the stock is not cheap until its ROE can rise to at least 6.5%

(which is not achievable in our forecast period). On the other hand, it is trading at 1.1x

EV/IC, versus its ROIC at 1.1% in 2016. Its current ROIC is 80% below our WACC

assumption. The EV/IC multiple suggests that the stock is not cheap unless its ROIC can

rise to at least 6%, which, again, is not achievable in our forecast horizon.

Last but not least, at its 2015 dividend per share, Unicom is trading at a dividend yield of

2.1%. We have factored in a 15% rise in dividend in 2016, and thus its yield should rise to

2.5%. This level of dividend yield is not particularly attractive. We also believe that it will

be difficult for Unicom to raise dividend further, given its high leverage (62% net debt to

equity) and slowing FCF growth.

Excitement about PPP likely overdone On September 28, the NDRC announced that Unicom would be one of the companies

included in the government’s ‘Public-Private Partnership” (PPP) pilot project. There are no

further details. The objective of PPP is understood to be encouraging private companies to

invest in SOEs, so that private capital can be channeled to fund SOEs, and help improve

the efficiency and competitiveness of the SOEs.

Since then, the market has been speculating that one of the large Chinese Internet

companies (ie, Baidu, Alibaba and Tencent) may take a strategic stake in Unicom, creating

the hope that Unicom can be transformed. Such speculation has been further fueled by

the recent announcement of a strategic cooperation relationship between Unicom and

Baidu. However, we are less optimistic. Although there are synergies that can be achieved

in such a deal, we expect significant challenges in how the private investor can influence

Unicom’s management and operations, owing to huge differences in corporate culture. It

is also possible that such an investment will take place at the parent company level in the

form of a minority stake, which will further limit its influence on the operations of the

listco.

Unicom’s fixed line revenue was only

39% of total service revenue in 2015,

vs. 58% at CT

0.84

0.04

1.14

0.21

-

0.20

0.40

0.60

0.80

1.00

1.20


China Unicom's P/B and EV/IC

Its 2016 dividend yield of 2.6% is not

particularly attractive

PPP creates hope that one of the

Chinese Internet giants may take a

stake in Unicom

We are less optimistic; cultural

differences will make any real

changes hard to achieve


Source: Jefferies estimates

Telecommunications

Assuming Coverage

21 November 2016



Chart 53: China Unicom’s Valuation Summary


Chart 54: China Unicom’s Income Statement


Mobile service

revenue

82,449 103,307 126,036 151,133 155,095 142,620 145,566 144,217 146,354 147,771 149,912

Voice 56,026 64,912 73,488 82,261 74,550 57,748 47,080 40,916 36,179 32,157 29,321

Data traffic 7,700 14,650 25,030 38,350 53,418 61,215 76,799 82,981 90,689 96,810 102,947

Other VASes 18,220 23,230 27,072 29,625 26,396 22,314 20,186 19,220 18,687 18,004 16,844

Others 503 515 446 897 731 1,343 1,500 1,100 800 800 800

Fixed line service

revenue

79,942 81,642 83,213 86,487 88,481 91,261 95,913 100,712 106,284 108,289 109,726

Voice 34,520 28,710 24,375 21,844 18,336 14,797 13,080 11,597 9,999 8,678 7,516

Internet and data 32,595 38,500 43,132 48,278 52,579 56,629 61,040 65,147 69,734 70,809 71,226

ICT 1,048 1,634 2,240 2,991 3,469 4,334 5,926 7,704 9,630 11,364 13,068

Leased line 5,589 6,859 8,086 8,389 8,879 9,404 10,332 11,366 12,389 13,256 14,051

VAS 4,860 4,562 4,367 3,996 4,324 5,132 4,715 4,098 3,732 3,382 3,064

Others 1,330 1,377 1,013 989 894 965 820 800 800 800 800

Other service

revenue

1,692 936 878 947 1,302 1,397 1,420 1,470 1,520 1,570 1,620

Sales of telecom

products

7,287 23,282 38,799 56,471 39,803 41,771 35,860 36,992 34,974 40,532 34,031

Total service

revenue

164,083 185,885 210,127 238,567 244,878 235,278 242,899 246,399 254,158 257,631 261,257

Total revenue 171,370 209,167 248,926 295,038 284,681 277,049 278,759 283,391 289,133 298,163 295,288

Opex

Interconnection

charges

13,727 16,380 18,681 20,208 14,599 13,093 11,861 11,409 8,362 7,804 7,318

Networks,

operations &

support

26,383 29,449 32,516 33,704 37,851 42,308 52,619 56,596 60,420 62,941 65,145

Employee benefit 23,327 26,601 28,778 31,783 34,652 35,140 37,073 38,741 39,903 40,901 41,923

S&M 24,628 28,750 35,037 42,991 40,193 31,965 33,352 33,590 30,014 28,057 28,589

G&A 12,953 14,836 16,215 18,973 21,218 22,995 22,995 23,570 24,277 25,005 25,755

Cost of telecom

products sold

10,688 29,739 45,040 63,416 43,397 44,046 39,267 39,748 38,472 44,754 38,417

Total opex 111,706 145,755 176,267 211,075 191,910 189,547 197,166 203,654 201,448 209,462 207,147

Dec 31, Rmb m 2014A 2015A 2016E 2017E 2018E 2019E

Revenue 284,681 277,049 278,759 283,391 289,133 298,163

EBITDA 92,771 87,502 81,593 79,736 87,685 88,701

vs consensus -1.8% -10.9%

Net profit 12,055 10,562 766 (714) 2,781 1,016

Basic EPS (Rmb) 0.51 0.44 0.03 (0.03) 0.12 0.04

vs consensus -76% -110%

EPS growth 15.9% -13.7% -92.7% -193.2% -489.5% -63.5%

PE 15.6 18.1 248.3 (266.4) 68.4 187.2

EV/EBITDA 3.6 3.8 4.1 4.2 3.8 3.7

ROAE 5.4% 4.6% 0.3% -0.3% 1.3% 0.5%

ROIC 5.2% 2.9% 1.1% 0.4% 1.5% 0.7%

Dividend yield 2.5% 2.1% 2.5% 2.5% 2.5% 2.5%

P/B 0.84 0.82 0.84 0.86 0.86 0.88

EV/IC 1.2 1.2 1.1 1.1 1.2 1.3

FCF yield to market cap 9.7% -2.2% -5.9% 4.3% 8.3% 7.7%

Unicom’s ROIC and ROE are forecast

to fall, and it could report a loss in

2017

Telecommunications

Assuming Coverage

21 November 2016



Chart 54: China Unicom’s Income Statement


EBITDA 59,664 63,412 72,659 83,963 92,771 87,502 81,593 79,736 87,685 88,701 88,141

EBITDA margin 35% 30% 29% 28% 33% 32% 29% 28% 30% 30% 30%

D&A 54,433 58,021 61,057 68,196 73,868 76,738 77,410 78,306 82,277 86,210 88,696

Operating profit 5,231 5,391 11,602 15,767 18,903 10,764 4,184 1,430 5,408 2,491 (555)

Finance costs 1,749 1,474 3,664 3,113 4,617 6,934 5,170 5,340 5,340 5,340 5,340

Interest income 142 230 240 173 283 438 800 1,200 1,600 2,000 2,300

Other income 1,221 1,451 1,343 887 1,362 9,767 1,205 1,760 2,030 2,200 2,300

Pretax income 4,845 5,598 9,521 13,714 15,931 14,035 1,019 (949) 3,698 1,351 (1,295)

Income tax 922 1,371 2,425 3,306 3,876 3,473 253 (235) 917 335 (321)

Net income 3,923 4,227 7,096 10,408 12,055 10,562 766 (714) 2,781 1,016 (974)

Basic EPS (Rmb) 0.16 0.18 0.30 0.44 0.51 0.44 0.03 (0.03) 0.12 0.04 (0.04)

DPS (Rmb) 0.08 0.10 0.12 0.16 0.20 0.17 0.20 0.20 0.20 0.20 0.20

Dividend payout

ratio

50% 56% 40% 36% 39% 39% 613% NA 169% 462% NA

WA shares O/S (m) 23,562 23,564 23,565 23,658 23,852 23,947 23,947 23,947 23,947 23,947 23,947

YoY Change (%)

Mobile service

revenue

25.3% 22.0% 19.9% 2.6% -8.0% 2.1% -0.9% 1.5% 1.0% 1.4%

Fixed line service

revenue

2.1% 1.9% 3.9% 2.3% 3.1% 5.1% 5.0% 5.5% 1.9% 1.3%

Other service

revenue

-44.7% -6.2% 7.9% 37.5% 7.3% 1.6% 3.5% 3.4% 3.3% 3.2%

Sales of telecom

products

219.5% 66.6% 45.5% -29.5% 4.9% -14.2% 3.2% -5.5% 15.9% -16.0%

Total service

revenue

13.3% 13.0% 13.5% 2.6% -3.9% 3.2% 1.4% 3.1% 1.4% 1.4%

Total revenue 22.1% 19.0% 18.5% -3.5% -2.7% 0.6% 1.7% 2.0% 3.1% -1.0%

Total opex 30.5% 20.9% 19.7% -9.1% -1.2% 4.0% 3.3% -1.1% 4.0% -1.1%

EBITDA 6.3% 14.6% 15.6% 10.5% -5.7% -6.8% -2.3% 10.0% 1.2% -0.6%

EBITDA margin -4.5% -1.1% -0.7% 4.1% -1.0% -2.3% -1.1% 2.2% -0.6% 0.1%

D&A 6.6% 5.2% 11.7% 8.3% 3.9% 0.9% 1.2% 5.1% 4.8% 2.9%

Operating profit 3.1% 115.2% 35.9% 19.9% -43.1% -61.1% -65.8% 278.1% -53.9% -122.3%

Pretax income 15.5% 70.1% 44.0% 16.2% -11.9% -92.7% n.a. n.a. -63.5% n.a.

Income tax 48.7% 76.9% 36.3% 17.2% -10.4% -92.7% n.a. n.a. -63.5% n.a.

Net income 7.7% 67.9% 46.7% 15.8% -12.4% -92.7% n.a. n.a. -63.5% n.a.

Basic EPS (Rmb) 12.5% 66.7% 46.7% 15.9% -13.7% -92.7% n.a. n.a. -63.5% n.a.

DPS (Rmb) 25.0% 20.0% 33.3% 25.0% -15.0% 15.3% 0.0% 0.0% 0.0% 0.0%


Telecommunications

Assuming Coverage

21 November 2016



Chart 55: China Unicom’s Balance Sheet


Chart 56: China Unicom’s Cash Flow Statement



Current assets

Cash & bank deposits 22,768 15,410 18,282 21,560 25,364 21,957 16,053 37,900 48,938 58,880 60,729

Accounts receivables 9,286 11,412 13,753 14,842 14,671 14,957 15,546 15,770 16,266 16,488 16,720

Inventories 3,728 4,651 5,803 5,536 4,378 3,946 4,712 4,372 4,232 4,923 4,226

Prepayments and other current assets 6,426 7,330 10,336 10,272 12,161 15,810 15,810 15,810 15,810 15,810 15,810


Long-term assets

PPE 366,060 381,859 430,997 431,625 438,321 454,631 452,221 447,835 441,806 432,885 422,566

Interest in associates - - - - 3,037 31,997 31,997 31,997 31,997 31,997 31,997

Due from related parties - - - - - 18,322 18,322 - - - -

Goodwill 2,771 2,771 2,771 2,771 2,771 2,771 2,771 2,771 2,771 2,771 2,771

Others 30,414 32,800 34,182 42,565 44,369 45,955 46,160 46,920 47,950 49,150 50,450

Total long-term assets 399,245 417,430 467,950 476,961 488,498 553,676 551,471 529,523 524,524 516,803 507,784

Total assets 441,453 456,233 516,124 529,171 545,072 610,346 603,592 603,375 609,770 612,904 605,269

Current liabilities

Short-term debt 59,785 70,372 139,240 129,470 112,694 106,380 106,380 106,380 106,380 106,380 106,380


Due to carriers and related parties 6,293 7,393 6,497 7,314 6,566 6,667 6,667 6,667 6,667 6,667 6,667

Advances from customers 28,906 35,722 42,345 49,841 46,892 48,357 48,357 48,357 48,357 48,357 48,357

Other current liabilities 4,110 3,956 3,932 3,768 3,931 4,111 4,111 4,111 4,111 4,111 4,111


Long-term liabilities

Long-term debt 35,020 34,502 2,536 13,483 23,880 40,676 50,676 50,676 50,676 50,676 50,676

Others 2,355 1,906 1,763 1,550 1,731 2,380 2,380 2,380 2,380 2,380 2,380

Total long-term liabilities 37,375 36,408 4,299 15,033 25,611 43,056 53,056 53,056 53,056 53,056 53,056

Shareholders' equity

Share capital 157,473 155,767 155,275 158,082 159,619 158,368 158,368 158,368 158,368 158,368 158,368

Retained profits 48,368 50,131 54,230 60,817 67,922 72,848 68,920 63,513 61,600 57,923 52,255

Total equity 205,841 205,898 209,505 218,899 227,541 231,216 227,288 221,881 219,968 216,291 210,623

Total liab and equity 441,453 456,233 516,124 529,171 545,072 610,346 603,592 603,375 609,770 612,904 605,269



EBITDA 59,664 63,412 72,659 83,963 92,771 87,502 81,593 79,736 87,685 88,701 88,141

Change in working capital 9,596 6,950 3,770 2,647 4,291 3,667 (13,181) 6,306 8,951 6,899 (503)

Interest received 148 230 242 173 283 319 800 1,200 1,600 2,000 2,300

Interest paid (2,025) (3,205) (4,372) (5,082) (4,631) (4,943) (5,170) (5,340) (5,340) (5,340) (5,340)

Income tax paid (1,039) (896) (1,679) (3,219) (4,620) (2,244) (253) 235 (917) (335) 321



Capex (75,555) (77,861) (86,783) (72,758) (69,586) (88,465) (75,000) (73,920) (76,247) (77,289) (78,377)

Disposal of PPE & other assets 375 1,431 1,086 1,544 797 2,336 0 18,322 0 0 0

Acquisition of interests in associates & JVs 0 (3,367) (10,314) 0 (3,075) (1,008) 0 0 0 0 0

Others (1,434) (3,173) (3,469) (5,896) (3,455) (4,217) 0 0 0 0 0

Net cash flow from investing (76,614) (82,970) (99,480) (77,110) (75,319) (91,354) (75,000) (55,598) (76,247) (77,289) (78,377)


Financing activities 23,494 11,058 34,287 4,612 (5,296) 8,070 10,000 0 0 0 0

Dividends paid (3,670) (2,070) (2,283) (2,686) (3,677) (4,643) (4,694) (4,694) (4,694) (4,694) (4,694)

Net cash flow from financing 19,824 8,988 32,004 1,926 (8,973) 3,427 5,306 (4,694) (4,694) (4,694) (4,694)

Net change in cash 9,554 (7,491) 3,144 3,298 3,802 (3,626) (5,904) 21,847 11,038 9,942 1,849

Effect of changes in forex rate 0 0 0 (42) 0 73 0 0 0 0 0

Beg balance 7,820 22,597 15,106 18,250 21,506 25,308 21,755 15,851 37,698 48,736 58,678

Ending balance 17,374 15,106 18,250 21,506 25,308 21,755 15,851 37,698 48,736 58,678 60,527

Telecommunications

Assuming Coverage

21 November 2016



Chart 57: China Unicom’s Major operating expense assumptions


Chart 58: China Unicom’s Fixed Asset Schedule


31-Dec 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Interconnection cost per min (Rmb) 0.02169 0.02218 0.02204 0.02113 0.01436 0.01364 0.01337 0.01310 0.00983 0.00953 0.00925

YoY change in employee benefit cost 14.0% 8.2% 10.4% 9.0% 1.4% 5.5% 4.5% 3.0% 2.5% 2.5%

YoY change in G&A cost 14.5% 9.3% 17.0% 11.8% 8.4% 0.0% 2.5% 3.0% 3.0% 3.0%

Fixed selling and marketing costs (Rmb m) 17,000 18,360 19,829 22,803 27,364 21,891 21,891 21,891 23,642 25,297 26,815

Variable selling cost per net add (Rmb) 322 384 437 484 240 185 190 250 250 250

YoY change in network operations cost 11.6% 10.4% 3.7% 12.3% 4.0% -6.8% 0.0% 5.0% 2.0% 2.0%

Tower leasing cost (Rmb m) 0 0 0 0 2,930 15,909 19,887 21,875 23,625 25,043

Rmb m 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Gross fixed assets

Beginning balance 728,638 791,981 846,858 941,643 995,055 1,033,878 1,022,907 1,097,907 1,171,827 1,248,074 1,325,363

Additions/capex 67,917 72,911 108,189 73,088 83,241 133,599 75,000 73,920 76,247 77,289 78,377

Disposal (4,574) (18,034) (13,404) (19,676) (44,418) (144,570) 0 0 0 0 0

Ending balance 791,981 846,858 941,643 995,055 1,033,878 1,022,907 1,097,907 1,171,827 1,248,074 1,325,363 1,403,740

Accumulated depr

Beg balance 377,662 426,327 464,999 510,950 563,430 595,557 568,276 645,686 723,992 806,268 892,478

Increase in depr 52,883 55,737 58,587 65,051 70,005 69,364 77,410 78,306 82,277 86,210 88,696

Impairment and disposal (4,218) (17,065) (12,636) (12,267) (37,878) (96,645) 0 0 0 0 0

Ending balance 426,327 464,999 510,950 563,734 595,557 568,276 645,686 723,992 806,268 892,478 981,174

Net fixed assets

Beg balance 350,976 365,654 381,859 430,693 431,625 438,321 454,631 452,221 447,835 441,806 432,885

Ending balance 365,654 381,859 430,693 431,321 438,321 454,631 452,221 447,835 441,806 432,885 422,566

Capex assumptions (Rmb m) 75,000 73,920 76,247 77,289 78,377

Capex to service revenue 42.8% 41.2% 47.5% 30.8% 34.7% 56.9% 30.9% 30% 30% 30% 30%

Telecommunications

Assuming Coverage

21 November 2016



Chart 59: China Unicom DCF Valuation


WACC and Terminal Valuation Calculation


Equity risk premium 7.80% Terminal growth rate 2%





WACC 5.1%

Rmb m 2016E 2017E 2018E 2019E 2020E

EBITDA 81,593 79,736 87,685 88,701 88,141



Capex (75,000) (73,920) (76,247) (77,289) (78,377)

Unleveraged FCF (7,625) 11,768 19,047 17,693 9,399

Unleveraged FCF + terminal value (7,625) 11,768 19,047 17,693 314,442


Discount factor 1.00 0.95 0.90 0.86 0.82

PV of unleveraged FCF (7,625) 11,193 17,229 15,221 257,290







7.3 1.0% 1.5% 2.0% 2.5% 3.0%

4.1% 7.7 10.0 13.5 19.2 29.7

4.6% 5.7 7.5 9.8 13.3 18.8

5.1% 4.3 5.6 7.3 9.6 13.0

5.6% 3.2 4.1 5.4 7.1 9.4

6.1% 2.2 3.0 4.0 5.2 6.9

WA

CC

Our DCF valuation of HK$7.26 per

share is based on a WACC of 5.1%

and a terminal growth rate of 2%,

equivalent to 3.5x EV/EBITDA

Telecommunications

Assuming Coverage

21 November 2016



Chart 60: Mobile Subscriber Assumptions


2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Population (m) 1,341.0 1,348.2 1,355.4 1,362.5 1,369.4 1,376.1 1,384.6 1,393.1 1,401.1 1,409.1 1,416.9

Pop growth % 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.6% 0.6% 0.6% 0.6% 0.6%

Pop net nadd (m) 7.2 7.2 7.2 7.1 6.9 6.6 8.5 8.5 8.0 8.0 7.8

Total mobile sub (m) 809.4 943.2 1,077.7 1,201.3 1,258.8 1,276.2 1,382.2 1,417.2 1,442.2 1,460.2 1,470.2

Penetration 60.4% 70.0% 79.5% 88.2% 91.9% 92.7% 99.8% 101.7% 102.9% 103.6% 103.8%

Net add (m) 0.0 133.7 134.5 123.5 57.6 17.4 53.0 35.0 25.0 18.0 10.0

No. of mobile sub (m)

CM 584.0 649.6 710.3 767.2 806.6 826.0 849.9 865.6 876.1 884.2 888.4

Unicom 134.9 167.1 206.8 248.5 266.6 252.3 263.5 270.5 276.0 279.7 281.7

CT 90.5 126.5 160.6 185.6 185.6 197.9 216.2 228.4 237.4 243.6 247.4

Total 809.4 943.2 1,077.7 1,201.3 1,258.8 1,276.2 1,329.5 1,364.5 1,389.5 1,407.5 1,417.5

Mobile sub market share

CM 72.2% 68.9% 65.9% 63.9% 64.1% 64.7% 63.9% 63.4% 63.1% 62.8% 62.7%

Unicom 16.7% 17.7% 19.2% 20.7% 21.2% 19.8% 19.8% 19.8% 19.9% 19.9% 19.9%

CT 11.2% 13.4% 14.9% 15.4% 14.7% 15.5% 16.3% 16.7% 17.1% 17.3% 17.5%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Net add (m)

CM 65.6 60.7 56.9 39.4 19.4 23.9 15.8 10.5 8.1 4.2

Unicom 32.2 39.7 41.7 18.1 (14.3) 11.1 7.0 5.5 3.8 2.0

CT 36.0 34.2 25.0 0.0 12.3 18.3 12.3 9.0 6.1 3.8

Total 133.7 134.5 123.5 57.6 17.4 53.0 35.0 25.0 18.0 10.0

Net add market share

CM 49.0% 45.1% 46.1% 68.5% 111.4% 45.0% 45.0% 42.0% 45.0% 42.0%

Uniom 24.1% 29.5% 33.7% 31.5% -82.0% 21.0% 20.0% 22.0% 21.0% 20.0%

CT 26.9% 25.4% 20.2% 0.1% 70.6% 34.5% 35.0% 36.0% 34.0% 38.0%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.5% 100.0% 100.0% 100.0% 100.0%

CM

No. of 4G subs 0.0 0.0 0.0 0.0 90.1 312.3 535.0 709.8 771.0 786.9 795.1

No. of 3G subs 20.7 51.2 87.9 191.6 245.8 169.4 105.0 55.0 35.0 25.0 18.0

No. of 3G+4G subs 20.7 51.2 87.9 191.6 335.8 481.7 640.0 764.8 806.0 811.9 813.1

Unicom

No. of 4G subs 0.0 0.0 0.0 0.0 2.1 44.2 106.1 167.7 193.2 204.2 211.3

No. of 3G subs 14.1 40.0 76.5 122.6 147.0 139.7 85.0 45.0 30.0 20.0 15.0

No. of 3G+4G subs 14.1 40.0 76.5 122.6 149.1 183.9 191.1 212.7 223.2 224.2 226.3

CT

No. of 4G subs 0.0 0.0 0.0 0.0 7.1 58.5 124.5 171.3 192.3 197.3 200.4

No. of 3G subs 12.3 36.3 69.1 103.1 111.6 84.7 50.0 35.0 25.0 18.0 15.0

No. of 3G+4G subs 12.3 36.3 69.1 103.1 118.6 143.1 174.5 206.3 217.3 215.3 215.4

Total

No. of 4G subs 0.0 0.0 0.0 0.0 99.3 414.9 765.6 1,048.8 1,156.5 1,188.4 1,206.8

No. of 3G subs 47.1 127.5 233.4 417.3 504.3 393.7 240.0 135.0 90.0 63.0 48.0

No. of 3G+4G subs 47.1 127.5 233.4 417.3 603.6 808.6 1,005.6 1,183.8 1,246.5 1,251.4 1,254.8

4G penetration

CM 0.0% 0.0% 0.0% 0.0% 11.2% 37.8% 63.0% 82.0% 88.0% 89.0% 89.5%

Unicom 0.0% 0.0% 0.0% 0.0% 0.8% 17.5% 40.3% 62.0% 70.0% 73.0% 75.0%

CT 0.0% 0.0% 0.0% 0.0% 3.8% 29.5% 57.6% 75.0% 81.0% 81.0% 81.0%

Total 0.0% 0.0% 0.0% 0.0% 7.9% 32.5% 57.6% 76.9% 83.2% 84.4% 85.1%

Telecommunications

Assuming Coverage

21 November 2016



Chart 61: Mobile Voice Assumptions


2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Avg MOU/user/month

CM - 525 514 487 455 431 410 391 376 357 343

Unicom - 361 352 332 313 295 273 262 252 239 229

CT - 313 296 291 295 290 290 285 270 254 239

Total - 471 453 426 401 382 364 348 333 316 302

YoY change in MOU/user/month

CM 0.0% 0.0% -2.2% -5.2% -6.6% -5.2% -4.9% -4.5% -4.0% -5.0% -4.0%

Unicom 0.0% 0.0% -2.6% -5.5% -5.8% -5.9% -7.4% -4.0% -4.0% -5.0% -4.0%

CT 0.0% 0.0% -5.6% -1.7% 1.3% -1.5% 0.1% -2.0% -5.0% -6.0% -6.0%

Total 0.0% 0.0% -3.8% -5.9% -5.9% -4.8% -4.7% -4.3% -4.3% -5.2% -4.3%

Rev per minute (Rmb)

CM 0.0994 0.0937 0.0878 0.0824 0.0730 0.0620 0.0546 0.0481 0.0423 0.0381 0.0350

Unicom 0.1060 0.0992 0.0932 0.0906 0.0770 0.0630 0.0554 0.0488 0.0439 0.0404 0.0379

CT 0.0977 0.0947 0.0965 0.0964 0.0834 0.0734 0.0624 0.0530 0.0461 0.0411 0.0369

Total 0.1001 0.0945 0.0894 0.0851 0.0748 0.0635 0.0557 0.0488 0.0431 0.0388 0.0357

YoY change in rev per minute

CM 0.0% -5.7% -6.3% -6.1% -11.4% -15.0% -12.0% -12.0% -12.0% -10.0% -8.0%

Unicom 0.0% -6.4% -6.1% -2.8% -15.0% -18.3% -12.0% -12.0% -10.0% -8.0% -6.0%

CT 0.0% -3.0% 1.9% -0.1% -13.6% -12.0% -15.0% -15.0% -13.0% -11.0% -10.0%

Total 0.0% -5.6% -5.4% -4.7% -12.1% -15.1% -12.3% -12.4% -11.8% -9.8% -8.0%

Total MOU (bn mins)

CM 3,462 3,887 4,192 4,316 4,294 4,221 4,122 4,028 3,927 3,770 3,645

Unicom 528 654 789 908 968 917 850 839 825 797 773

CT 296 408 509 604 656 668 722 759 756 733 704

Total 4,286 4,949 5,490 5,828 5,917 5,806 5,694 5,627 5,507 5,300 5,121

Mobile voice traffic share

CM 80.8% 78.5% 76.4% 74.1% 72.6% 72.7% 72.4% 71.6% 71.3% 71.1% 71.2%

Unicom 12.3% 13.2% 14.4% 15.6% 16.4% 15.8% 14.9% 14.9% 15.0% 15.0% 15.1%

CT 6.9% 8.2% 9.3% 10.4% 11.1% 11.5% 12.7% 13.5% 13.7% 13.8% 13.7%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Mobile voice revenue (Rmb bn)

CM 344.0 364.2 368.0 355.7 313.5 261.9 225.1 193.6 166.0 143.5 127.6

Unicom 56.0 64.9 73.5 82.3 74.6 57.7 47.1 40.9 36.2 32.2 29.3

CT 28.9 38.6 49.2 58.2 54.7 49.0 45.0 40.2 34.9 30.1 26.0

Total 428.9 467.7 490.7 496.2 442.7 368.6 317.2 274.7 237.1 205.7 182.9

Mobile voice revenue share

CM 80.2% 77.9% 75.0% 71.7% 70.8% 71.0% 71.0% 70.5% 70.0% 69.7% 69.8%

Unicom 13.1% 13.9% 15.0% 16.6% 16.8% 15.7% 14.8% 14.9% 15.3% 15.6% 16.0%

CT 6.7% 8.3% 10.0% 11.7% 12.3% 13.3% 14.2% 14.6% 14.7% 14.6% 14.2%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Telecommunications

Assuming Coverage

21 November 2016



Chart 62: Mobile Data Assumptions


2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

DOU per 3G+4G sub per month (MB)

CM 300 154 134 135 185 326 760 1,064 1,436 1,867 2,240

Unicom - 295 263 226 267 348 636 891 1,203 1,563 1,876

CT - 124 114 170 201 353 658 921 1,243 1,616 1,939

Total - 280 252 249 300 473 717 1,007 1,361 1,769 2,123

YoY change in DOU per 3G+4G sub

CM 0% -49% -13% 1% 37% 76% 133% 40% 35% 30% 20%

Unicom 0% 0% -11% -14% 18% 31% 83% 40% 35% 30% 20%

CT 0% 0% -8% 48% 18% 76% 86% 40% 35% 30% 20%

Total 0% 0% -10% -1% 20% 58% 51% 40% 35% 30% 20%

Rev per MB (Rmb)

CM 0.2961 0.2760 0.2296 0.2000 0.1329 0.0718 0.0539 0.0377 0.0283 0.0226 0.0199

Unicom - 0.1532 0.1363 0.1421 0.1229 0.0880 0.0549 0.0385 0.0288 0.0231 0.0203

CT - 0.2403 0.1682 0.1308 0.1277 0.0861 0.0557 0.0390 0.0293 0.0234 0.0206

Total - 0.2315 0.1901 0.1715 0.1298 0.0766 0.0544 0.0381 0.0285 0.0228 0.0201

YoY change in Rev per MB

CM 0% -7% -17% -13% -34% -46% -25% -30% -25% -20% -12%

Unicom 0% 0% -11% 4% -14% -28% -38% -30% -25% -20% -12%

CT 0% 0% -30% -22% -2% -33% -35% -30% -25% -20% -12%

Total 0% 0% -18% -10% -24% -41% -29% -30% -25% -20% -12%

Mobile data traffic (bn MB)

CM 103 161 290 527 1,133 2,761 5,129 8,967 13,536 18,124 21,845

Unicom - 96 184 270 435 696 1,398 2,158 3,145 4,196 5,071

CT - 36 72 175 267 555 1,239 2,104 3,160 4,195 5,011

Total - 293 546 972 1,835 4,011 7,767 13,229 19,840 26,515 31,927

Mobile data traffic share

CM 0.0% 55.0% 53.1% 54.2% 61.8% 68.8% 66.0% 67.8% 68.2% 68.4% 68.4%

Unicom 0.0% 32.7% 33.6% 27.8% 23.7% 17.3% 18.0% 16.3% 15.9% 15.8% 15.9%

CT 0.0% 12.3% 13.2% 18.0% 14.6% 13.8% 16.0% 15.9% 15.9% 15.8% 15.7%

Total 0.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Mobile data rev (Rmb bn)

CM 30.5 44.4 66.5 105.4 150.6 198.3 276.6 338.4 383.2 410.4 435.4

Unicom - 14.7 25.0 38.4 53.4 61.2 76.8 83.0 90.7 96.8 102.9

CT - 8.7 12.2 22.9 34.1 47.8 69.1 82.1 92.5 98.2 103.2

Total - 67.8 103.7 166.6 238.1 307.3 422.5 503.5 566.3 605.5 641.5

Mobile data rev share

CM 65.6% 64.1% 63.2% 63.2% 64.5% 65.5% 67.2% 67.7% 67.8% 67.9%

Unicom 21.6% 24.1% 23.0% 22.4% 19.9% 18.2% 16.5% 16.0% 16.0% 16.0%

CT 12.8% 11.7% 13.7% 14.3% 15.5% 16.4% 16.3% 16.3% 16.2% 16.1%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Telecommunications

Assuming Coverage

21 November 2016



Chart 63: Mobile Market Forecast Summary


2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

Total mobile revenue (Rmb bn)

CM 485.2 537.0 569.5 578.7 563.2 552.2 589.2 623.2 634.1 631.4 634.0

Unicom 82.4 103.3 126.0 151.1 155.1 142.6 142.6 144.2 146.4 147.8 149.9

CT 47.7 68.2 92.8 113.8 120.3 124.5 139.6 146.4 150.3 150.0 149.6

Total 615.4 708.5 788.4 843.6 838.5 819.3 871.3 913.8 930.7 929.1 933.5

Mobile revenue market share

CM 78.8% 75.8% 72.2% 68.6% 67.2% 67.4% 67.6% 68.2% 68.1% 68.0% 67.9%

Unicom 13.4% 14.6% 16.0% 17.9% 18.5% 17.4% 16.4% 15.8% 15.7% 15.9% 16.1%

CT 7.8% 9.6% 11.8% 13.5% 14.3% 15.2% 16.0% 16.0% 16.1% 16.1% 16.0%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

ARPU (Rmb)

CM - 72.6 69.8 65.3 59.6 56.4 58.6 60.5 60.7 59.8 59.6

Unicom - 57.0 56.2 55.3 50.2 45.8 45.8 45.0 44.6 44.3 44.5

CT - 52.4 53.9 54.8 54.0 54.1 56.1 54.9 53.8 52.0 50.8

Total - 67.4 65.0 61.7 56.8 53.9 55.6 56.5 56.3 55.4 55.1

Mobile data access as a % of total revenue

CM 6.3% 8.3% 11.7% 18.2% 26.7% 35.9% 46.9% 54.3% 60.4% 65.0% 68.7%

Unicom 14.2% 19.9% 25.4% 34.4% 42.9% 53.8% 57.5% 62.0% 65.5% 68.7%

CT 12.7% 13.1% 20.1% 28.3% 38.4% 49.5% 56.1% 61.5% 65.5% 69.0%

Total 9.6% 13.2% 19.8% 28.4% 37.5% 48.5% 55.1% 60.8% 65.2% 68.7%

Telecommunications

Assuming Coverage

21 November 2016



Chart 64: Local Fixed Voice Revenue Assumptions


2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

No. of fixed lines (m)

CM NA NA NA NA NA NA NA NA NA NA NA

Unicom 96.6 92.9 92.0 87.6 82.1 73.9 67.4 61.4 55.9 50.4 45.9

CT 175.1 169.6 163.0 155.8 143.6 134.3 127.5 119.5 112.0 105.0 98.5

Total 271.7 262.4 255.0 243.4 225.6 208.2 194.9 180.9 167.9 155.4 144.4

Fixed line net add (m)

CM NA NA NA NA NA NA 0.0 0.0 0.0 0.0 0.0

Unicom -6.2 -3.8 -0.9 -4.3 -5.6 -8.2 -6.4 -6.0 -5.5 -5.5 -4.5

CT -13.5 -5.5 -6.6 -7.2 -12.2 -9.2 -6.8 -8.0 -7.5 -7.0 -6.5

Total -19.7 -9.2 -7.5 -11.5 -17.8 -17.4 -13.3 -14.0 -13.0 -12.5 -11.0

Local fixed line market share

CM 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Unicom 35.6% 35.4% 36.1% 36.0% 36.4% 35.5% 34.6% 34.0% 33.3% 32.4% 31.8%

CT 64.4% 64.6% 63.9% 64.0% 63.6% 64.5% 65.4% 66.0% 66.7% 67.6% 68.2%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Wireline local voice traffic (pulses m)


Unicom 155,562 125,275 81,496 64,793 69,879 59,084 52,507 44,068 36,614 30,630 26,016

CT 251,425 206,371 172,175 148,690 130,439 110,935 94,308 84,467 73,611 65,094 56,160

Total 406,987 331,646 253,671 213,483 200,318 170,019 146,816 128,535 110,225 95,724 82,176

Wireline local voice traffic market share (pulses m)


Unicom 38.2% 37.8% 32.1% 30.4% 34.9% 34.8% 35.8% 34.3% 33.2% 32.0% 31.7%

CT 61.8% 62.2% 67.9% 69.6% 65.1% 65.2% 64.2% 65.7% 66.8% 68.0% 68.3%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Wireline local voice traffic per access line per month (pulses)

CM - - - - - - - - - - -

Unicom 130 110 73 60 69 63 62 57 52 48 45

CT 115 100 86 78 73 67 60 57 53 50 46

Total 120 103 82 71 71 65 61 57 53 49 46

Wireline long distance usage (mins m)

CM - - - - - - - - - - -

Unicom 26,787 21,553 18,201 15,986 14,372 12,822 11,010 9,432 8,027 6,700 5,666

CT 69,751 54,067 42,199 34,329 30,066 26,503 21,062 18,524 15,972 14,060 12,453

Total 96,538 75,620 60,400 50,315 44,438 39,325 32,072 27,956 23,999 20,761 18,119

Wireline long distance traffic per access line per month (mins)

CM - - - - - - - - - - -

Unicom 22.4 19.0 16.4 14.8 14.1 13.7 13.0 12.2 11.4 10.5 9.8

CT 32.0 26.1 21.1 17.9 16.7 15.9 13.4 12.5 11.5 10.8 10.2

Total 28.6 23.6 19.5 16.8 15.8 15.1 13.3 11.6 10.1 8.8 7.8

Fixed line voice revenue (Rmb m)

CM - - - 5,185 5,867 5,391 4,847 3,980 3,659 3,340 3,020

Unicom - 28,695 24,375 21,844 18,336 14,797 13,080 11,597 9,999 8,678 7,516

CT 62,498 49,764 43,335 38,633 33,587 29,610 25,988 22,969 20,555 18,487 16,238

Total 62,498 78,459 67,710 65,662 57,790 49,798 43,914 38,546 34,213 30,505 26,773

Fixed line voice rev per access line (Rmb)

CM - - - - - - - - - - -

Unicom - 25.2 22.0 20.3 18.0 15.8 15.4 15.0 14.2 13.6 13.0

CT 28.6 24.1 21.7 20.2 18.7 17.8 16.5 15.5 14.8 14.2 13.3

Total - 24.5 21.8 22.0 20.5 19.1 18.2 17.1 16.3 15.7 14.9

Telecommunications

Assuming Coverage

21 November 2016



Chart 65: Local Fixed Data Revenue Assumptions


2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

No. of broadband subs (m)

CM NA NA NA NA NA 55.0 80.7 102.7 122.7 139.7 152.7

Unicom 47.2 55.7 63.9 64.6 68.8 72.3 76.3 81.3 85.8 89.8 93.3

CT 63.5 76.8 90.1 100.1 107.0 113.1 123.2 133.7 142.7 150.7 158.2

Total 110.7 132.5 154.0 164.7 175.7 240.4 280.2 317.7 351.2 380.2 404.2

Broadband net add (m)

CM - - - - - - 25.7 22.0 20.0 17.0 13.0

Unicom 8.7 8.4 8.2 0.8 4.1 3.5 3.9 5.0 4.5 4.0 3.5

CT 10.0 13.3 13.3 10.0 6.9 6.1 10.2 10.5 9.0 8.0 7.5

Total 18.7 21.8 21.5 10.8 11.0 64.7 39.8 37.5 33.5 29.0 24.0

Broadband market share

CM NA NA NA NA NA 22.9% 28.8% 32.3% 34.9% 36.8% 37.8%

Unicom 42.7% 42.0% 41.5% 39.2% 39.1% 30.1% 27.2% 25.6% 24.4% 23.6% 23.1%

CT 57.3% 58.0% 58.5% 60.8% 60.9% 47.0% 44.0% 42.1% 40.6% 39.6% 39.1%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Braodband ARPU (Rmb)

CM NA NA NA NA NA 32.0 32.3 32.5 33.0 34.0 35.0

Unicom 57.1 56.4 54.4 61.4 62.2 63.6 50.4 51.0 52.0 50.0 48.0

CT 77.1 72.2 66.6 62.1 59.1 56.3 54.9 54.0 53.0 50.0 48.0

Total 69.0 65.8 61.7 67.4 68.5 58.7 47.7 46.6 46.0 44.3 43.2

Broadband revenue (Rmb m)

CM NA NA NA 12,089 16,204 18,339 26,025 35,779 44,645 53,546 61,421

Unicom 29,822 35,226 39,370 45,986 50,201 53,960 44,895 48,195 52,104 52,650 52,704

CT 54,127 60,801 66,738 70,821 73,485 74,285 77,861 83,249 87,908 88,032 88,975

Total 83,949 96,027 106,108 128,896 139,890 146,584 148,780 167,222 184,657 194,228 203,100

Braodband revenue market share

CM NA NA NA 9.4% 11.6% 12.5% 17.5% 21.4% 24.2% 27.6% 30.2%

Unicom 35.5% 36.7% 37.1% 35.7% 35.9% 36.8% 30.2% 28.8% 28.2% 27.1% 25.9%

CT 64.5% 63.3% 62.9% 54.9% 52.5% 50.7% 52.3% 49.8% 47.6% 45.3% 43.8%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

YoY change in leased line rev

Unicom 22.7% 17.9% 3.7% 5.8% 5.9% 9.9% 10.0% 9.0% 7.0% 6.0%

CT 14.7% 9.8% 10.4% -1.9% 2.0% 2.6% 5.0% 4.0% 4.0% 3.0%

Total 17.2% 12.4% 8.2% 0.6% 3.4% 5.2% 6.8% 5.9% 5.2% 4.2%

Leased line revenue

Unicom's leased line revenue (Rmb m) 5,589 6,859 8,086 8,389 8,879 9,404 10,332 11,366 12,389 13,256 14,051

CT's leased line revenue (Rmb m) 12,371 14,193 15,577 17,203 16,869 17,213 17,662 18,545 19,287 20,059 20,660

Total 17,960 21,052 23,663 25,592 25,748 26,617 27,995 29,911 31,676 33,314 34,711

Leased line rev market share

Unicom 31.1% 32.6% 34.2% 32.8% 34.5% 35.3% 36.9% 38.0% 39.1% 39.8% 40.5%

CT 68.9% 67.4% 65.8% 67.2% 65.5% 64.7% 63.1% 62.0% 60.9% 60.2% 59.5%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Unicom's fixed line VAS rev per line per month (Rmb) 4.1 4.0 3.9 3.7 4.2 5.5 5.5 5.3 5.3 5.3 5.3

Unicom's fixed line VAS revenue (Rmb m) 4,860 4,562 4,367 3,996 4,324 5,132 4,715 4,098 3,732 3,382 3,064

Fixed line VAS revenue (Rmb m)

Unicom NA NA NA 4,367 3,996 4,324 4,715 4,098 3,732 3,382 3,064

CT NA NA NA 14,230 13,130 13,028 11,153 10,862 10,373 9,583 8,983

Total NA NA NA 18,597 17,126 17,352 15,868 14,960 14,105 12,965 12,047

Fixed line VAS revenue market share

Unicom 23.5% 23.3% 24.9% 29.7% 27.4% 26.5% 26.1% 25.4%

CT 76.5% 76.7% 75.1% 70.3% 72.6% 73.5% 73.9% 74.6%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Telecommunications

Assuming Coverage

21 November 2016



Chart 66: Fixed Line Revenue Summary


Fixed line revenue (Rmb m) 2010A 2011A 2012A 2013A 2014A 2015A 2016E 2017E 2018E 2019E 2020E

CM NA NA NA 21,702 28,452 31,929 41,977 53,804 64,473 74,961 84,334

Unicom 78,704 81,627 83,213 86,487 88,481 91,261 95,913 100,712 106,284 108,289 109,726

CT 165,414 162,365 165,350 165,100 167,111 168,763 174,200 182,948 191,284 195,122 199,496

Total 244,118 243,992 248,563 273,289 284,044 291,953 312,090 337,464 362,041 378,372 393,556

Fixed line revenue market share

CM 0% 0% 0% 8% 10% 11% 13% 16% 18% 20% 21%

Unicom 32% 33% 33% 32% 31% 31% 31% 30% 29% 29% 28%

CT 68% 67% 67% 60% 59% 58% 56% 54% 53% 52% 51%

Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Telecommunications

Assuming Coverage

21 November 2016



Long Term Financial Model Drivers

Cagr of revenue per MB of mobile

data 2015-2020

-22.6%

Cagr of DOU per user per month

2015-2020

47.1%

Network maintenance cost as a %

of gross PPE

3.7%

Capex to service revenue 2020 30%

Other Considerations:

Low morale of middle management due

to lack of financial incentives may make

operational improvement harder to

achieve.

China Mobile owns 38% of China Tower

Corp, which may do an IPO in 2017. If its

IPO is successful and the value goes up, it

will be mildly positive for China Mobile

(but China Mobile is unlikely to sell any of

its stake any time soon).

China Mobile Capex to Sales Ratio (2006-2020E)


195,600

31% 31%

35%

30%

26%25%

23%

32%

36%

33%

29% 29%

30% 30% 30%

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

-

50,000

100,000

150,000

200,000

250,000 Rmb mn

China Mobile is the world’s and China’s largest mobile operator in terms of the number of

users. It started out as the incumbent mobile operator in China, and adopted the GSM

standard. It then started building a 3G network in 2009, based on the TD-SCDMA standard

developed by China. In 2014, it was awarded a 4G license, based on the TD-LTE standard.

By the end of September 2016, it had 844m of mobile users, 481m of which are 4G users.

In November 2015, it acquired China Tietong (or China Railcom) and officially entered the

fixed line market.

Reports over the next few quarters could

show EBITDA and profit growth still under

pressure

Dividend announcement in the upcoming

2016 results (Mar/Apr 2017) could

disappoint investors.

2017 capex guidance to be announced at

the upcoming 2016 results could also

disappoint by not having a big year-on-

year drop.

Catalysts

Target Investment Thesis

The government will likely continue to

pressure all three telecom operators to

further lower prices, improve coverage and

upgrade data speed and technology.

Current industry structure is likely viewed

by the government as sustainable, thus no

further industry consolidation is in sight.

There is always risk of having to do more

national services, such as an early,

aggressive 5G rollout.

DCF-based TP at HK$69.24, implying 3.0x

2017 EV/EBITDA and 4.2% yield.

Upside Scenario

Management may decide to pay a large

special dividend for 2016. It currently has

net cash of HK$23 per share.

A large (>15%) reduction in its 2017 capex

guidance will prompt the market to

extrapolate further declines. A 2ppt decline

in its terminal capex to sales ratio will yield

a DCF value of HK$82.70, implying 3.9x

2017 EV/EBITDA and 3.5% dividend yield.

Downside Scenario

No hike in dividend payout and no special

dividend for 2016 may prompt the stock

to trade below its DDM value of HK$56.0,

implying 2.1x 2017 EV/EBITDA and 5.6%

dividend yield.

China Telecom and/or China Unicom may

introduce more aggressive handset

subsidies and pricing than expected to

increase market share and network

utilization.

Long Term Analysis

Scenarios

Telcos Capex to Sales Ratio

Source: OECD Digital Economy Outlook 2015, company data, Jefferies

30% 30%

39%

43%

31%30% 29%

31%

34%

39%

34%

18% 17% 17%

14% 14% 14%15% 15% 15%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Cumulative

China OECD

2016-2017E EPS JEFe vs. Consensus

Source: Bloomberg, Jefferies estimates

5.45

5.58

5.29

5.74

5.00

5.10

5.20

5.30

5.40

5.50

5.60

5.70

5.80

2016E 2017E

JEFe Consensus

Rmb

Recommendation / Price Target

Ticker Rec. PT

941.HK Underperform HK$69.2



Company Description

THE LO

NG

VIE

W

Peer Group

China Mobile

Underperform: HK$69.24 Price Target

Telecommunications

Assuming Coverage

21 November 2016





data 2015-2020

-24.9%


2015-2020

40.6%


of gross PPE

7.0%

Capex to service revenue 2020 27.0%

Other Considerations




achieve.

China Telecom owns 27.9% of China

Tower Corp, which may do an IPO in

2017. If its IPO is successful and the value

goes up, it will be mildly positive for

China Telecom (but it is unlikely to sell

any of its stake).

China Telecom Capex to Sales Ratio (2006-2020E)


109,904

27% 26%

39%

47%

33%31%

28% 29%27%

37%

31%29% 28% 27% 27%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

-

20,000

40,000

60,000

80,000

100,000

120,000Rmb mn

China Telecom is the country’s largest integrated operator. It inherited the incumbent fixed

line operations of the government in 21 provinces in the south, but was also given the

right to operating fixed lines in the remaining 10 provinces. In 2008 it bought the CDMA

network from China Unicom, which turned China Telecom into an integrated fixed line

and mobile operator. In 2009, it was awarded a 3G license based on CDMA2000

technology. In Feb. 2015, it received a 4G license based on FDD-LTE technology. By the

end of September 2016, it had 129m fixed line users and 212m mobile users (107m of

which are 4G users).



pressure


the upcoming 2016 results could


year drop.

No dividend hike in the upcoming result

announcement could be a mild

disappointment. Management will unlikely

give positive guidance.

Catalysts









Financially constrained to raise dividend.

TP HK$3.05 based on our DCF valuation,


dividend yield.

Upside Scenario



extrapolate further declines. China

Telecom’s valuation most sensitive to

capex assumptions among the three

Chinese operators.

More facilities sharing with China Unicom

will be positive for both operators in

containing operating costs.

A 2ppt drop in capex to sales assumption

would yield a DCF of HK$6.9 per share,

implying 5.6x 2017 Ev/EBITDA..

Downside Scenario

No dividend increase and no material cut

in capex guidance in the upcoming result

announcement could cause the stock to

trade closer to its DDM value of HK$1.46,


dividend yield.

China Mobile and/or China Unicom may

decide to step up marketing costs to

further ramp up their 4G user bases.

Early data suggests there may be a risk

that price elasticity of mobile data

demand has been exhausted.

Long Term Analysis

Scenarios


Source: OECD Digital Economy Outlook 2015, company data, Jefferies

30% 30%

39%

43%

31%30% 29%

31%

34%

39%

34%

18% 17% 17%

14% 14% 14%15% 15% 15%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Cumulative

China OECD



0.25

0.26

0.24

0.27

0.22

0.23

0.24

0.25

0.26

0.27

0.28

2016E 2017E

JEFe Consensus

Rmb


Ticker Rec. PT




Company Description

TH

E LO

NG

VIE

W

Peer Group

China Telecom

Underperform: HK$3.02

Telecommunications

Assuming Coverage

21 November 2016





data 2015-2020

-25.4%


2015-2020

40.0%


of gross PPE

2.9%

Capex to service revenue 2020 30.0%

Other Considerations




achieve.

China Unicom owns 28.1% of China

Tower Corp, which may do an IPO in

2017. If the IPO is successful and the value

goes up, it will be mildly positive for

China Unicom (but it is unlikely to sell any

of its stake).

China Unicom Capex to Sales Ratio (2006-2020E)


133,900

32% 32%

50%

75%

43%41%

47%

31%35%

57%

31% 30% 30% 30% 30%

0%

10%

20%

30%

40%

50%

60%

70%

80%

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000Rmb mn

China Unicom started out as a new entrant in China’s mobile market, operating both a

GSM and CDMA network. In 2008, it acquired China Netcom, which inherited the

incumbent fixed line operations of the government in 10 provinces in the northern part of

China, and has the right to offering fixed line services in the remaining 21 provinces. In that

same year, it sold its CDMA business to China Telecom. In 2009, it was awarded a 3G

license based on WCDMA technology. In Feb. 2015, it received a 4G license based on FDD-

LTE technology. By the end of September 2016, it had 69m fixed line users and 262m

mobile users (89m of which are 4G users).



pressure


the upcoming 2016 results could


year drop.

No dividend hike in the upcoming result

announcement could be a mild

disappointment. Management will unlikely

give positive guidance.

Catalysts









Unlikely to raise dividends owing to high

leverage.

TP of HK$7.26 is based on our DCF

valuation, implying 3.7x 2017 EV/EBITDA

and 3.1% dividend yield.

Upside Scenario



extrapolate further declines.

More facilities sharing with China Telecom

will be positive for both operators in

containing operating costs.

A 2ppt decrease in the capex to sales

assumption will yield a DCF value of

HK$13.8 per share.

Downside Scenario

No dividend increase and no material cut

in capex guidance in the upcoming result

announcement could cause the stock to

trade closer to its DDM value of HK$3.92,


dividend yield.

China Mobile and/or China Telecom may

decide to step up marketing costs to

further ramp up their 4G user bases.

Early data suggests there may be a risk

that price elasticity of mobile data

demand has been exhausted.

Long Term Analysis

Scenarios



30% 30%

39%

43%

31%30% 29%

31%

34%

39%

34%

18% 17% 17%

14% 14% 14%15% 15% 15%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Cumulative

China OECD



0.03

(0.04)

0.13

0.31

(0.10)

(0.05)

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

2016E 2017E

JEFe Consensus

Rmb


Ticker Rec. PT




Company Description

THE LO

NG

VIE

W

Peer Group

China Unicom

Underperform: HK$7.26 Price Target

Telecommunications

Assuming Coverage

21 November 2016



Company DescriptionChina Mobile is China's largest mobile carrier, providing GSM and TD-SCDMA mobile services.It has three brands, including the flagshipbrand “GoTone”, basic prepaid brand “Easyown” and a premium prepaid brand targeting youth “M-zone”.

China Telecom is China's largest fixed-line carrier and 3rd largest mobile carrier, providing CDMA mobile service, broadband and fixed-linetelephony services.

China Unicom is China's 2nd largest mobile and fixed-line carrier, providing GSM and WSCDMA mobile services, broadband and fixed-linetelephony services.

Analyst Certification:I, Edison Lee, CFA, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.Registration of non-US analysts: Edison Lee, CFA is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2241 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in this report receivescompensation based in part on the overall performance of the firm, including investment banking income. We seek to update our research asappropriate, but various regulations may prevent us from doing so. Aside from certain industry reports published on a periodic basis, the large majorityof reports are published at irregular intervals as appropriate in the analyst's judgement.

Investment Recommendation Record(Article 3(1)e and Article 7 of MAR)

Recommendation Published , 06:31 ET. November 21, 2016Recommendation Distributed , 06:35 ET. November 21, 2016

Company Specific DisclosuresFor Important Disclosure information on companies recommended in this report, please visit our website at https://javatar.bluematrix.com/sellside/Disclosures.action or call 212.284.2300.

Explanation of Jefferies RatingsBuy - Describes securities that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period.Hold - Describes securities that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within a 12-month period.Underperform - Describes securities that we expect to provide a total return (price appreciation plus yield) of minus 10% or less within a 12-monthperiod.The expected total return (price appreciation plus yield) for Buy rated securities with an average security price consistently below $10 is 20% or morewithin a 12-month period as these companies are typically more volatile than the overall stock market. For Hold rated securities with an averagesecurity price consistently below $10, the expected total return (price appreciation plus yield) is plus or minus 20% within a 12-month period. ForUnderperform rated securities with an average security price consistently below $10, the expected total return (price appreciation plus yield) is minus20% or less within a 12-month period.NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/or Jefferies policies.CS - Coverage Suspended. Jefferies has suspended coverage of this company.NC - Not covered. Jefferies does not cover this company.Restricted - Describes issuers where, in conjunction with Jefferies engagement in certain transactions, company policy or applicable securitiesregulations prohibit certain types of communications, including investment recommendations.Monitor - Describes securities whose company fundamentals and financials are being monitored, and for which no financial projections or opinionson the investment merits of the company are provided.

Valuation MethodologyJefferies' methodology for assigning ratings may include the following: market capitalization, maturity, growth/value, volatility and expected totalreturn over the next 12 months. The price targets are based on several methodologies, which may include, but are not restricted to, analyses of marketrisk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF,P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns,and return on equity (ROE) over the next 12 months.

Jefferies Franchise PicksJefferies Franchise Picks include stock selections from among the best stock ideas from our equity analysts over a 12 month period. Stock selectionis based on fundamental analysis and may take into account other factors such as analyst conviction, differentiated analysis, a favorable risk/rewardratio and investment themes that Jefferies analysts are recommending. Jefferies Franchise Picks will include only Buy rated stocks and the numbercan vary depending on analyst recommendations for inclusion. Stocks will be added as new opportunities arise and removed when the reason for

Telecommunications

Assuming Coverage

21 November 2016



https://javatar.bluematrix.com/sellside/Disclosures.action


inclusion changes, the stock has met its desired return, if it is no longer rated Buy and/or if it triggers a stop loss. Stocks having 120 day volatility inthe bottom quartile of S&P stocks will continue to have a 15% stop loss, and the remainder will have a 20% stop. Franchise Picks are not intendedto represent a recommended portfolio of stocks and is not sector based, but we may note where we believe a Pick falls within an investment stylesuch as growth or value.

Risks which may impede the achievement of our Price TargetThis report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, thefinancial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions basedupon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance ofthe financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, andincome from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financialand political factors. If a financial instrument is denominated in a currency other than the investor's home currency, a change in exchange rates mayadversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities suchas ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk.

Other Companies Mentioned in This Report• Alibaba Group Holding Limited (BABA: $93.39, BUY)• Baidu Inc. (BIDU: $164.38, BUY)• China Mobile Limited (941 HK: HK$84.20, UNDERPERFORM)• China Telecom Corp Ltd. (728 HK: HK$3.65, UNDERPERFORM)• China Unicom (Hong Kong) Ltd. (762 HK: HK$9.01, UNDERPERFORM)• Tencent Holdings Ltd. (700 HK: HK$193.60, BUY)

For Important Disclosure information on companies recommended in this report, please visit our website at https://javatar.bluematrix.com/sellside/Disclosures.action or call 212.284.2300.

Distribution of RatingsIB Serv./Past 12 Mos.

Rating Count Percent Count Percent

BUY 1103 51.98% 325 29.47%HOLD 858 40.43% 168 19.58%UNDERPERFORM 161 7.59% 17 10.56%

Telecommunications

Assuming Coverage

21 November 2016





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Documents

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