Xtep International (1368 HK)pg.jrj.com.cn/acc/Res/CN_RES/INVEST/2013/8/7/4a62148b-bfc4-442a-… · China-listed smartphone space, we prefer ZTE (763 HK) and TCL Communication (2618

China/Hong Kong | TECHNOLOGY

Please read the analyst certification and other important disclosures on last page

China Smartphone 7 August 2013

Marching forward We initiate coverage on the China smartphone sector. Since 2012, China has been the largest smartphone market in the world, in part because of increasing handset subsidies from the top-three China telecom operators, rising demand for mobile internet and competitive models from leading local smartphone vendors. Among the smartphone component suppliers, we prefer AAC Technologies (2018 HK) because of its diverse customer portfolio, R&D capabilities and market-leading position during a period of mass adoption of smartphones and tablets. Within the Hong Kong and China-listed smartphone space, we prefer ZTE (763 HK) and TCL Communication (2618 HK) owing to their cost competitiveness and superior in-house R&D capabilities. Recent market volatility aside, we believe both companies are well positioned for FY13F/14F.

Analysts Ronnie Ho (852) 2533 2486 [email protected] Candy Tai (852) 2844 3606 [email protected]


2

Table of Content Marching forward ...................................................................................................................................... 3

Investment summary ................................................................................................................................ 4

China smartphone market in the fast lane ................................................................................................ 6

Android OS and MTK solution lower entry barriers ................................................................................... 7

Samsung and Apple’s differing fortunes in China ...................................................................................... 8

Local players recording record-high market shares .................................................................................. 9

Exports for local players the next growth driver ...................................................................................... 11

4G LTE the next big thing ....................................................................................................................... 12

Chipsets, memory, displays are the big ticket items ................................................................................ 14

Local component manufacturers are riding the mass adoption of smartphones ...................................... 15

From off-line retail channel to on-line e-purchases ................................................................................. 16

Hong Kong- and China-listed smartphone stocks price performance since 2012 .................................... 18

TCL Communication (2618 HK) .............................................................................................................. 19

China Wireless (2369 HK) ...................................................................................................................... 26

Sunny Optical (2382 HK) ........................................................................................................................ 33

ZTE Corporation (763 HK) ...................................................................................................................... 40

AAC Technologies (2018 HK) ................................................................................................................. 43

Lenovo Group (992 HK) ......................................................................................................................... 47


3

China Smartphone

Marching forward We initiate coverage on the China smartphone

sector. Since 2012, China has been the largest smartphone market in the world, in part because of increasing handset subsidies from the top-three China telecom operators, rising demand for mobile internet and competitive models from leading local smartphone vendors. We expect China smartphone unit shipments to grow 46%/21% in FY13F/14F and unit sales to grow 46%/21% YoY to 310m/375m in FY13F/14F, representing around 30% of the worldwide market share.

Leading China smartphone brands gaining market share. According to IDC, Lenovo and ZTE were the number 4 and 5 smartphone brands in 2Q13, with unit sales of 11.3m units and 10.1m, respectively, up 131% YoY and 58% YoY. Because of their competitive pricing and appealing product designs, Chinese brands have been gaining traction in the global competitive smartphone arena, in the process unseating Sony, Motorola, Blackberry, HTC and Nokia from the top of the vendor list. Maturing software, chipset and component technologies will be the reason Chinese smartphone brands will gain further global market share in FY13F/14F, in our view.

Mixed performance by smartphone component manufacturers. Among the smartphone component suppliers, we prefer AAC Technologies (2018 HK, Outperform) because of its diverse customer portfolio, R&D capabilities and market-leading position during a period of mass adoption of smartphones and tablets. In contrast, we are cautious on Sunny Optical (2382 HK, Neutral) because of intense price competition for 5MP/8MP camera modules from the local manufacturers.

ZTE and TCL Communication our preferred plays. Within the Hong Kong/China-listed smartphone space, we prefer ZTE (763 HK, Outperform) and TCL Communication (2618 HK, Outperform) owing to their exposure to the rapidly growing smartphone market, their cost competitiveness and superior in-house R&D capabilities. Recent market volatility aside, we believe both companies are well positioned for FY13F/14F.

China smartphone valuation matrix

Lenovo ZTE AAC

Sunny Optical

TCL Comm

China Wireless

Share price (HK$) 7.31 13.60 35.95 8.34 3.33 2.59 Stock code (HK) 992 763 2018 2382 2618 2369 Rating* N O O N O O TP (HK$) 7.6 20.0 42.8 8.7 4.5 3.4 Upside (%) 3.9 47.0 19.0 4.3 35.1 31.2 EPS, YoY (%) FY13F 32.7 N/A 35.8 28.5 (78.8) 48.1 FY14F 7.7 25.6 14.2 25.9 N/A 25.8 P/E (x) FY13F 15.4 17.5 14.8 14.7 N/A 11.6 FY14F 14.3 13.6 12.6 11.5 8.9 9.2 Yield (%) FY13F 1.9 1.4 2.7 2.0 0.0 2.6 FY14F 2.1 1.8 3.2 2.6 3.9 3.3 P/B (x) FY13F 3.7 1.9 4.6 3.6 1.7 2.0 FY14F 3.2 1.7 3.7 3.1 1.4 1.7 ROE (%) FY13F 23.7 8.5 31.4 19.7 (1.9) 17.3 FY14F 22.0 9.8 29.2 21.0 15.8 18.7 Closing price on 7 August 2013 * CCBIS ratings: O = Outperform; N = Neutral; U = Underperform Source: CCBIS estimates

Ronnie Ho (852) 2533 2486 [email protected] Candy Tai (852) 2844 3606 [email protected]

mailto:[email protected]



4

Investment summary

Since the introduction of the Apple iPhone by Steve Jobs in early 2007, followed by the Android operating system (OS) by Google in 2008, we have witnessed a second handset revolution characterized by the mass adoption of the smartphone in 2010-2012. These three years brought stellar unit growth of 76%, 59% and 26%. But now, as the party begins to wind down, we look for slower global smartphone growth in FY13F and FY14F, including slower unit sales growth by leading brands like Samsung and Apple. The shining exception is China, where smartphone unit sales growth looks set to buck the global trend, with robust growth in FY13F and FY14F, possibly topping 46% and 21% unit sales growth, respectively. It is almost certain that China will remain the largest smartphone market in the world, with over 30% global market share by FY15F, in our view.

Samsung/Apple/HTC YTD price performance Lenovo/ZTE/Coolpad/TCL price performance

650,000

750,000

850,000

950,000

1,050,000

1,150,000

1,250,000

1,350,000

1,450,000

1,550,000

100200300400500600700800900

1,0001,1001,2001,300

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13

Local currencyLocal currency

Apple (LHS) HTC (LHS) Samsung (RHS)

0

4

8

12

16

20

24

28

32

Jan-11 May-11 Sep-11 Feb-12 Jun-12 Nov-12 Mar-13 Aug-13

HK$

Lenovo ZTE China Wireless TCL Source: Bloomberg Source: Bloomberg

High-end smartphone unit growth decelerating. Samsung Electronics (005930 KS, Not Rated), Apple (AAPL US, Not Rated), Nokia (NOK US, Not Rated), HTC (2498 TT, Not Rated) and BlackBerry (BBRY US, Not Rated) were the top-five smartphone vendors in 2011. Samsung and Apple have long held the number one and two spots in the smartphone market by wide margins on the strength of their impressive product designs and superior distribution channels and due to robust demand in developed countries. However, we believe growth momentum for both these leading brands will slow in FY13F and FY14F because of intense competition, a slew of affordable new products produced by Chinese brands and product saturation in developed markets.

China smartphone brands gaining traction. Despite the heavy competition within China’s smartphone market, Chinese smartphone brands have fared well against their international rivals. ZTE and Lenovo unseated Blackberry and HTC from the global top-five smartphone vendor list in part because of their competitive pricing and better product designs. We strongly believe Chinese smartphone brands will grab further market share in FY13F and FY14F. Turning their backs on the old days of the low-margin US$100 low-end smartphone, Chinese brands of today are stepping up efforts to penetrate the relatively lucrative mid-end smartphone segment. Strong ties with domestic and overseas telecom operators, improving economies of scale, better product designs and maturing operating systems (OS), chipset and component technologies have helped leading local players. Among listed Chinese smartphone names, we prefer Huawei, ZTE (763 HK, Outperform) and TCL Communication (2618 HK, Outperform) owing to their improving economies of scale and higher sales in overseas markets brought about by their strong ties with leading overseas telecom operators.


5

Chinese component manufacturers like AAC Technologies and Sunny Optical are benefiting from higher product specifications. Among Hong Kong- and China-listed smartphone component suppliers, we prefer AAC Technologies because of its (1) diverse customer portfolio, which includes virtually all leading smartphone brands except LG; (2) its outstanding R&D capabilities for design-in projects; and (3) its market-leading position during a period characterized by the mass adoption of smartphones and tablets. In contrast, we are cautious on China’s largest handset camera manufacturer, Sunny Optical (2382 HK, Neutral), because of intense price competition for 5MP camera modules from other local suppliers, notably Truly and O-film.

Risks: (1) Lower-than-expected mass adoption of smartphones in China, (2) intense price competition from domestic and international smartphone brands, and (3) the increasing cost of manufacturing in China.

China technology sector valuation matrix

Stock CCBIS Share price* Market cap EPS growth (%) P/E (x) Company code rating (local currency) (US$m) CY13F CY14F CY15F CY13F CY14F CY15F China handset brands Lenovo 992 HK Neutral 7.31 9,763 7.7 13.1 6.5 14.3 12.7 11.9 ZTE 763 HK Outperform 13.60 7,964 N/A 25.6 26.2 17.5 13.6 10.8 China Wireless 2369 HK Outperform 2.59 701 48.1 25.8 25.4 11.6 9.2 7.3 TCL 2618 HK Outperform 3.33 489 (78.8) N/A 42.5 N/A 8.9 6.2 Average 14.5 11.1 9.1 Global handset brands Apple AAPL US Not Rated 465.25 422,678 (12.5) 8.0 8.3 11.9 11.0 10.2 Samsung 005930 KS Not Rated 1,222,000.00 160,918 74.4 7.9 5.4 6.1 5.6 5.3 Nokia NOK US Not Rated 4.06 15,205 N/A 313.6 (8.8) N/A 58.9 64.6 LGE 066570 KS Not Rated 74,100.00 10,841 (332.1) 74.5 12.7 16.2 9.3 8.2 BlackBerry BBRY US Not Rated 9.57 5,016 (52.8) 35.6 (38.2) N/A N/A N/A HTC 2498 TT Not Rated 150.00 4,263 (85.4) 185.3 (1.4) 51.0 17.9 18.1 Average 21.3 20.5 21.3 Handset components and others MediaTek 2454 TT Not Rated 350.00 15,754 43.7 26.3 5.1 18.9 14.9 14.2 AAC 2018 HK Outperform 35.95 5,674 35.8 14.2 17.9 14.8 12.6 10.7 Largan Precision 3008 TT Not Rated 1,020.00 4,564 57.4 15.0 10.4 15.6 13.5 12.3 FIH 2038 HK Not Rated 4.09 3,921 (113.9) 250.0 (71.4) N/A 25.1 N/A TPK Holding 3673 TT Not Rated 302.50 3,301 N/A 6.6 (2.0) 6.2 5.9 6.0 Truly International 732 HK Not Rated 4.05 1,464 39.5 13.1 33.3 11.3 10.0 7.5 Spreadtrum SPRD US Not Rated 29.80 1,453 44.8 11.0 2.0 10.3 9.3 9.1 Unimicron Tech 3037 TT Not Rated 23.75 1,219 (24.9) 28.4 2.6 14.1 10.9 10.7 BYD Electronic 285 HK Not Rated 4.07 1,179 64.7 17.9 13.0 11.9 10.1 8.9 Sunny Optical 2382 HK Neutral 8.34 1,072 28.5 25.9 16.7 14.7 11.5 9.7 Merry Electronics 2439 TT Not Rated 68.50 402 60.2 8.2 (9.0) 15.6 14.4 15.9 Average 13.3 12.6 10.5 * Price as at close on 7 August 2013 Source: Bloomberg, CCBIS estimates


6

China smartphone market in the fast lane

According to IDC, smartphone unit sales in China topped 213m in 2012. China has been the world's largest smartphone market since 2012. In part because of increasing subsidies for mobile devices from top-three China telecom operators, rising demand for mobile internet and competitive models from leading local smartphone vendors, we forecast total smartphone shipments will grow 46% YoY in FY13F and 21% YoY in FY14F to reach 310m units and 375m units, respectively. China has evolved into one of the most competitive smartphone markets in the world, with domestic smartphone brands accounting for over 50% of total smartphone unit sales in China and with Lenovo, Coolpad, ZTE and Huawei all finding spots atop China’s smartphone top-sellers list, just behind industry leader Samsung. By the end of 2012, local players had unseated leading international smartphone brands, including Apple, Nokia and HTC.

China smartphone unit growth (2010-2014F) China smartphone market share (2012)

15%

35%

55%

75%

95%

115%

135%

155%

0

50

100

150

200

250

300

350

400

2010 2011 2012 2013F 2014F

m unit

China Smartphone unit sales China Smartphone unit growth

Samsung22%

Lenovo11%

Apple8%

Coolpad9%

ZTE9%

Huawei10%

HTC5%

Nokia3%

Xiaomi4%

Ginoee6%

Motorolla4%

Other9%

Source: IDC, CCBIS estimates Source: iiMedia Research

In our view, the open platform Android mobile OS has played a vital role in the success of Chinese local smartphone brands. That said, the winning formula for ZTE, Huawei, Lenovo and Coolpad came down to three major advantages: (1) strong ties with local operators; (2) customized solutions for local users; and (3) attractive exterior designs at competitive prices. Looking further into the future, we believe improving economies of scale, strong growth in local markets and upcoming 4G LTE opportunities in China will support growth for China’s top-tier domestic smartphone players.

We are seeing increasing demand for mobile internet connectivity, which accounts for the success of 4G LTE. This standard offers lightning-quick internet connectivity to mobile devices, with which end users will be able to download and stream music and videos while on the road even faster than they do at present. For example, a movie will now take just 10-15 minutes to download via a 4G network when once it took at least an hour. Faster connections appeal to mobile gamers who will be able to enjoy the richly detailed and complex online multiplayer games availed by the faster speeds of the new standard. There is now a high probability that 4G licenses will be granted in China late this year. Once the licenses are granted, a flood of opportunities will arise for China’s leading Chinese handset makers in FY14 and FY15F.

http://www.techinasia.com/domestic-brands-amount-60-chinas-smartphone-market/


7

Android OS and MTK solution lower entry barriers

The introduction of the open platform Android OS from Google presented a great opportunity for smartphone brands interested in entering China’s highly competitive smartphone market leaving individual brands to focus on customized user interfaces, exterior designs, and sales and marketing. With component prices falling rapidly, ASPs for low-end smartphones have fallen as low as US$50-60.

Because of the open platform solutions and the greater number of price competitive participants, the Android OS has dominated the China smartphone market. According to ZDC’s survey on the China smartphone market, 43.1% of Android smartphone models available in May 2013 cost under RMB1,000, while 40.8% cost over RMB1,000 but below RMB2,000. Clearly feature phones are losing their price advantage as Android smartphones rapidly become more affordable.

Price range of the Android smartphones in China market in May 2013

MediaTek’s Chipset

438414

100

3911 13

20.9%

29.4%

22.3%

10.9%8.2% 8.3%

5%

10%

15%

20%

25%

30%

35%

0

80

160

240

320

400

480

1,000 orbelow

1,000-2,000 2,001-3,000 3,001-4,000 4,001-5,000 5,000 orabove

RMBUnit (LHS) User concern (RHS)

Source: ZDC Source: MediaTek

Besides the Android OS, we believe the MediaTek (MTK) solution is also playing an important part in the mass low-end smartphone adoption taking place in China. MediaTek has been the largest mobile chipset solution provider for white-label handsets in China. It has helped fuel the sales growth of China’s low-cost handsets by providing integrated, customized chipsets that significantly shorten the time and cost of marketing a new product. Traditionally, the typical cycle for handset manufacturers has been nine months. MediaTek’s approach has reduced time-to-market on average to four-to-six months. It has delivered more sophisticated chipsets over the past year destined for entry-level smartphones produced in China.

In December 2012, MediaTek launched the world’s first commercialized quad-core system on a chip (SoC) developed specifically for mid- to high-end smart devices. The quad-core SoC solution enables the mobile ecosystem to bring the performance and features associated with premium mobile devices to the mainstream market at affordable prices. It has also lowered barriers to entry thereby increasing competition and widening the purchase options of consumers. The MT6572 chip, designed for entry-level smartphones, is the company’s first smartphone chip that integrates a four-in-one connectivity chip. It greatly reduces the bill-of-material (BOM) cost, simplifies product development and enhances time to market. We believe the latest quad-core MT6589, consisting of a power-efficient quad-core A7 ARM CPU, will shorten the product development cycle for local smartphone players in China while availing them of a cost-effective chipset solution.


8

Samsung and Apple’s differing fortunes in China

In 2012, among foreign companies, only Samsung and Apple managed to capture more than a 5% share of the China smartphone market. Samsung led the China smartphone market in 2012 with 30m smartphones shipped. According to Strategy Analytics, Samsung’s leading position in the domestic market extended into 1Q13 with 12.5m smartphones shipped, representing a market share of 18.5%. Second through fifth place went to Chinese brands, including second-place Huawei and third-place Lenovo, which sold 8.1m and 7.9m smartphones, respectively. Fourth and fifth place went to Coolpad and ZTE, which managed to deliver 7.0m and 6.4m units, respectively. Apple landed in sixth place with 6.1m iPhones sold in 1Q13. In our view, Samsung is in better position than Apple to take advantage of surging demand for low- to mid-end smartphones in China, because Samsung offers a broader range of smartphone models, including the Galaxy Grand which goes for RMB2,700, the Galaxy Style which sells for RMB1,700 and the relatively cheap Galaxy Trend at RMB900.

Apple – iPhone 5 Samsung – Galaxy Mega

Source: Apple Source: Samsung

Apple has had little success in China. One of Apple’s most successful products, the iPhone, was first unveiled in January 2007. The launch of the iPhone instantly raised the bar of the entire smartphone industry. Released to the public in June 2007, the first generation iPhone utilized a 2G GSM network data service and was equipped with a multi-touch screen that allowed users to input information in the same way they would using a traditional physical keyboard. The first iPhone was initially only available in the US and certain western European markets. Apple’s latest iPhone product, the iPhone 5, was introduced in 4Q12. Apple is still the second-largest smartphone player in the world, though only the sixth-largest in China. We put the failure of Apple in China down to its single-product strategy and lack of TD-SCDMA solution to cater the largest local telecom operator, China Mobile.

Samsung still the most powerful player in the field. Samsung was the best-selling smartphone brand in the world with unit sales topping 72.4m units in 2Q13, representing a 44% YoY increase according to IDC. Samsung unseated Apple as the top-selling brand in 3Q11 and, since then, has maintained its position at the top from 1Q12 to 2Q13, six conservative quarters. The success of Samsung was largely due to its much-faster-than-peer model roll-out schedule and better exterior designs. With an over 30% global market share, Samsung is number one within the global smartphone space by a long shot. Significantly, Samsung was also the number-one smartphone brand in China. Yet despite its impressive track record, Samsung now faces the prospect of decelerating growth momentum within the high-end smartphone market and intense competition from emerging Chinese smartphone brands.


9

Local players recording record-high market shares

Thanks to (1) improving R&D capabilities and economies of scale; (2) competitive pricing; (3) the low smartphone penetration rate in China; and (4) subsidies from top-three operators, domestic smartphone makers dominate China’s smartphone market. Local smartphone brands accounted for over 50% of total smartphone unit sales in China in 1Q13.

Improving R&D capabilities and economies of scale

In order to benefit from increasing demand for smartphones, domestic smartphone markers have continued to strengthen their R&D capabilities and scale of production. Take Huawei, the largest China smartphone vendor, as an example: Huawei prides itself on its investment in research and development, with 70,000 of its 150,000 employees in R&D. And the results speak for themselves: Huawei’s high-end product, the Ascend P6, is billed as the world's slimmest 4G LTE smartphones. The scale of Huawei’s worldwide smartphone shipments is expected to surge from 32m units in 2012 to 50m-60m units in 2013F.

Competitive pricing

Improving economies of scale have meant that domestic smartphone vendors have been able to keep production costs low and offer their smartphones at very low prices, affordable enough for low- and middle-class Chinese consumers. The average income of Chinese consumers is not high, which tends to restrict them to purchasing low-cost smartphones. It follows that Chinese smartphone makers selling smartphones for RMB2,000 or below have an advantage over their more expensive foreign rivals. The iPhone, for example, sells for about RMB5,000 in China and, accordingly, its marketing targets upper-middle-class professionals. In 2012, about 77% of China’s smartphones sold at RMB2,000 or below, while 14.6% were sold in the RMB2,000 to RMB3,000 range.

2012 China smartphone market by price China smartphone penetration rate

RMB1,000or below

35%

RMB1,000-2,00042%

RMB2,000-3,00015%

RMB3,000-4,0005%

RMB4,000or above

3%

8.3%

15.2%

25.8%

55.0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

2010 2011 2012F 2013F Source: iiMedia Source: EnfoDesk


10

China’s low smartphone penetration rate

China’s increasing urbanization and rising demand for mobile services have resulted in it having the largest population of mobile phone users in the world, roughly 1.1b by the end of 2012. Despite strong GDP growth, the wealth effect from rising wages, and improving 3G coverage, China’s 3G mobile penetration rate was still at the relatively low level of 27.6% by the end of 1H13, partly due to the late issuance of 3G licenses relative to developed countries. As smartphone prices continue to fall and thanks to the efforts of China’s telecom operators, the smartphone penetration rate in China is likely to reach 55% by 2013F, in our view. Competitive pricing and stronger business relationships with leading China telecom operators are likely to enable domestic smartphone makers to maintain their dominance over China’s smartphone market.

Subsidies from the top-three operators

The top-three telecom operators, China Mobile, China Unicom and China Telecom are benefiting greatly from China’s smartphone revolution, as rising smartphone penetration accelerates uptake of their respective 3G services, generating higher revenue than 2G services. Since the number of 3G subscribers is still relatively small, the operators are desperate to expand subscriber numbers by offering generous handset subsidies. China Unicom sets aside about 40% of its 3G revenue to underwrite purchases of smartphones. However, it is China Mobile that is the most generous operator doling out handset subsidies and investing in terms of absolute dollars.

Percentage of 3G subscribers for CM/CU/CT

3G net add subscribers per month January 2012 to June 2013

3%

11%

19%

27%

35%

43%

51%

Jan-11 May-11 Sep-11 Jan-12 Jun-12 Oct-12 Feb-13 Jun-13CU 3G subscribers CT 3G subscribers CM 3G subscribers

0

1

2

3

4

5

6

7

8

9

10

Jan-1

2

Feb-1

2

Mar-1

2

Apr-1

2

May-1

2

Jun-1

2

Jul-1

2

Aug-

12

Sep-

12

Oct-1

2

Nov-1

2

Dec-1

2

Jan-1

3

Feb-1

3

Mar-1

3

Apr-1

3

May-1

3

Jun-1

3

m subscribers

China Unicom China Telecom China Mobile Source: Company data Source: Company data

China Mobile. By June 2013, China mobile had 137.8m 3G subscribers, representing 18.6% of its total mobile subscribers. The company now plans to spend RMB27b on handset subsidies in 2013, up from RMB23.8b in 2012.

China Telecom had 87.3m 3G subscribers by June 2013, representing 50% of its total mobile subscribers. It spent RMB21.8b on handset subsidies in 2012 and plans to spend more in 2013.

China Unicom had 100m 3G subscribers by June 2013, representing 38.2% of its total mobile subscribers. The company spent RMB6.1b on handset subsidies and will increase its handset subsidies in 2013.


11

Exports for local players the next growth driver

With the saturation of the smartphone market in developed countries, the battleground for smartphone customers is shifting quickly to emerging markets including Brazil, Russia and India. Chinese smartphone makers are eying lucrative export opportunities in 2013.

According to IDC, worldwide smartphone shipments will grow 32.7% YoY in 2013 to reach 958.8m units, up from 722.5m units in 2012. IDC also predicts global smartphone shipments in 2013 will surpass those of feature phones for the first time, with smartphones expected to account for 52.2% of worldwide handset shipments. Emerging markets are likely to account for 64.8% of all smartphones shipped in 2013 and these markets are on track to achieve a 45% rise in shipment volume. Smartphones have become increasingly popular in the emerging markets even though average personal income in these markets is still far less than in developed markets. Smartphone vendors have made deep forays into the low- to mid-end markets in the developing world. As this trend continues, smartphone blended ASPs are expected to drop 8.6% YoY to US$372 in 2013 and subsequently fall as low as US$309 by 2017, with emerging market demand the main catalyst for this change. By competing at the low- to mid-end of the market, major Chinese smartphone makers like Huawei, Lenovo, ZTE, Coolpad, TCL and Xiaomi have gained a considerable leg up on their high-end rivals.

2013F worldwide smartphone forecasts by market 2013F worldwide smartphone share by market

45.4%

14.3%

32.7%

10%

15%

20%

25%

30%

35%

40%

45%

50%

0

100

200

300

400

500

Emerging Developed Total

US$

ASP (LHS) YoY shipment growth (RHS)

Emerging markets

65%

Developed markets

35%

Source: IDC Source: IDC

Often, Chinese smartphone makers collaborate with local telecom operators, distributors and retail chains, to distribute their phones within foreign markets. For example, Coolpad began selling its Quattro 4G in the United States through MetroPCS, a mobile network operator. Coolpad’s smartphone was sold for less than US$100 under some promotions. Huawei also has big ambitions within the international market. In June 2013, it introduced a phone called the Ascend P6 in London through multiple mobile operators, including O2, Three and EE. Huawei planned to sell the phone in 100 different countries, including China and many European markets. Ascend P6 costs much less than an iPhone 5 or Galaxy S4, though it comes equipped with the quad-core 1.5GHz processor, an 8MP camera and a 4.7” screen. It is quite light too, weighing only 120g.


12

4G LTE the next big thing

Utilization of 3G networks is still low among the top-three telecom operators, especially the home-grown TD-S 3G service providers. It is also no secret that China Mobile, because of incompetence delivering 3G services and a lack of variety in smart-devices is now looking to fast forward its home-grown TD-LTE 4G network commercialization schedule. The head of China’s Ministry of Industry and Information Technology (MIIT) Mr. Miao Wei, stated that China is going to issue 4G licenses for TD-LTE networks by 4Q13, which is earlier than previously announced. We expect this to accelerate the deployment of China’s high-speed network. Shortly after the Mr. Miao Wei’s speech, MIIT allocated Band 41 (2500MHz-2690MHz) for TD-LTE usage as of October 2012. Not surprisingly, the earlier-than-expected TD-LTE roll-out timeline was followed by non-stop lobbying for 4G licenses over the last two years by China Mobile, which still had fresh in its memory the rapid loss of market share in the mobile market due to its use of the homegrown TD-SCDMA mobile standard for its 3G mobile network. We believe the realization by MIIT that China was falling behind the rest of the world in 4G mobile data services, must have put pressure on the telecom regulator to accelerate its 4G timetable. China Mobile has been running trials of its 4G services using technology based on a standard called TD-LTE that was the natural successor to its homegrown 3G standard.

China Mobile accelerated TD-LTE scale deployment

Source: China Mobile

China Mobile is currently the only telecom operator in China that employs TD-LTE technology, and it is now leading the way in establishing a 4G LTE network in China in the same way that it aggressively laid the groundwork for mass TD-LTE adoption. The company tested its TD-LTE network in 2012 by running trials on over 20,000 base stations across 13 cities. It announced in December 2012 that it would procure through an open tender for 70,000 LTE terminal devices, up from 34,000 devices previously planned. China Mobile plans to expand its TD-LTE network trial to 100 cities by 2013 using 200,000 base stations, which will be either new stations or stations upgraded from existing TD-SCDMA base stations. By 2014, China Mobile intends to own 350,000 TD-LTE base stations in China, with all of them required to support Band 41. The company’s purchase volume of TD-LTE terminals in 2013 represents a tenfold increase from 2012. In addition to the TD-LTE standard, China Mobile’s terminals are also expected to support FDD-LTE, GSM, TD-SCDMA and WCDMA networks. In order to encourage the take-up of dual-mode, multi-band terminals, the company has adopted a dual-path technology strategy that focuses not only on TD-LTE, but also on the FDD-LTE network. In December 2012, China Mobile set up a dual TD/FDD network in Hong Kong using frequency bands of 2,330-2,360MHz for TD-LTE and 2,555-2,570MHz and 2,675-2,690MHz for FDD-LTE operation. On the mobile-device side, China Mobile will launch LTE handset trials in 2H13. The company will distribute trial LTE handsets in 3Q13 and begin commercial trials in 4Q13.


13

Both China Unicom, the only WCDMA operator in China, and China Telecom, the only CDMA2000 operator in China, are likely to adopt FDD-LTE as their 4G mobile telecom standard. It is no surprise that both companies believe that FDD-LTE technology, having been adopted by most leading telecom operators around the world, is a more mature technology than TD-LTE and, as such, represents a more straight-forward path for both companies to migrate to 4G at the least cost. China Unicom may employ 1,940-1,955MHz and 2,130-2,145MHz, the frequency bands currently used for WCDMA operations, while China Telecom may use 1,920-1,935MHz and 2,110-2,125MHz, currently used for CDMA 2000, for their respective upgrades to 4G. However, it is still too early to speculate on the exact schedule for the issuance of 4G licenses for China Unicom and China Telecom because the government is intent on ensuring the success of the home-grown TD-LTE standard given the earlier failure of 3G TD-SCDMA.

Mobile devices about to take off

4G offers lightning-quick internet connectivity for mobile devices. This means end users will be able to download and stream music and videos much more easily and rapidly while on the road. With superior download speeds, a standard definition movie will take just 10-15 minutes to download via 4G whereas before it could take an hour or more. Though 4G mass adoption is still two-to-three years away, we believe leading China smartphone makers like Huawei, ZTE, Lenovo, Coolpad, TCL and Xiaomi will benefit greatly because of their more appealing product designs and comprehensive distribution channels.


14

Chipsets, memory, displays are the big ticket items

Today’s smartphone combines the functions of a personal computer, mobile phone, camera, personal media player and recorder. Some of the functions now considered “basic” for smartphones include the ability to surf the internet, play multimedia games, touch-screen capability, the ability to take high-quality digital photos, GPS navigation capability and the ability to connect with other devices (e.g., Auto, Tablet, PC, etc.). Of course, today’s smartphones must allow users to seamlessly communicate across a wide range of network technologies (3G, 4G) and frequencies across the globe. To allow for such an incredible range of functionality smartphones must rely on numerous different components. We list some of these components below, along with the functionality they allow.

Chipsets. The chipset controls the logic and communications functionality of the smartphone. The chipset typically contributes 10-15% of bill of materials (BOM) costs. Key chipsets include the application processor (AP) and the baseband processor (BB). It is the CPU or “brain” of the smartphone that delivers the high-intensity media and graphics most users are accustomed to seeing. The speed and performance of this chipset is a major differentiating factor in modern smartphones.

Memory. The growing complexity behind modern smartphone functionality has forced manufacturers to rely on ever more sophisticated memory to support that functionality. Memory takes up 10-15% of BOM costs. There are two types of memory in a smartphone: (1) volatile memory, which allows the device to run multiple applications at the same time, and (2) non-volatile memory, which is the data storage hub of the smartphone, where memory is retained even after the device is powered off.

Touch displays. It typically consists of the display and the touch screen, which in aggregate comprise 20-25% of the smartphone BOM cost. The display is the screen that allows us to read text messages and E-mail, watch videos and surf the web. The key differentiator for smartphones is the size and pixel resolution of the display. Most smartphones today use liquid crystal displays (LCD), either the thin film transistor (TFT) variety or in-plane switching LCDs (IPS-LCD), with the latter offering better viewing angles and lower battery consumption. Touch screens allow users to interact directly with the phone’s interface for data input. Recently, capacitive touch has been gaining in popularity since it allows for multi-touch interfaces.

Other components. Modern smartphones include many other components that support the logic, communications, memory and user interface of the phone. Collectively these components can contribute anywhere from 30 to 40% of a smartphone’s BOM; however, no component on its own can be said to make up a large part of vendor/manufacturer’s BOM cost. Also, while there are varying degrees of differentiation between different manufacturers, overall, these are commoditized parts. Key components included in this category include:

Passive ICs. Semiconductors and chips used for power management, noise cancellation, voice recognition, accelerometers, etc.

Mechanical components. The physical form of the phone as well as other key hardware like speakers, camera, buttons, the key pad etc.


15

Local component manufacturers are riding the mass adoption of smartphones

We expect handset component suppliers to benefit from increasing shipment volume and continuous product specification upgrades by China’s smartphone makers. Compared with feature phones, smartphones must adhere to much more stringent specifications. Changes in specifications mean new orders for parts which supports the blended ASPs of China’s leading component suppliers of acoustic parts (required to produce better sound quality), camera modules (denser megapixels) and LCDs (better resolution screens with touch capabilities).

Acoustic players benefit from better sound quality requirements

AAC (2018 HK, Outperform) is one of the world’s foremost vertically integrated manufacturers of miniature components. It designs, manufactures and distributes a comprehensive suite of acoustic and non-acoustic products, including receivers, speakers, microphones and antennas. The ASP increment through upgrades in product specification and wide ranging products offered by the company is expected to keep driving AAC’s growth in 2013F. In 2012, AAC has obtained 259 additional acoustic and non-acoustic patents, bringing its total portfolio to 908 patents.

Goertek (002241 CH, Not Rated) is principally engaged in the manufacture and distribution of electronic components including micro electro-acoustic components and consuming electro-acoustic products. The company will benefit from industry-wide acoustic upgrades. Goertek is now courting large smartphone companies in a bid to expand its already impressive list of customers that includes Samsung, Apple, LG, Sony and other major Chinese smartphone customers (e.g. Huawei). With this momentum behind it, Goertek can look forward to another high growth year in 2013F.

Cameras players benefit from higher pixel migration requirement

Largan (3008 TT, Not Rated) is one of the leading manufacturers of handset lenses. Given its superior technology in high-end camera lenses, Largan will benefit from rapid growth in China smartphone demand and the industry’s aggressive pixel migration towards high-pixel resolution lenses. The company’s customers include Apple, HTC, Motorola, Nokia, Samsung, and leading China handset brands.

Sunny Optical (2382 HK, Neutral), the major optical component supplier to Chinese smartphone makers, will benefit from the smartphone boom in China and the ongoing upgrade to faster camera resolutions in 2013F. Sunny Optical focuses on the development of high-end products. Having ramped up its in-house 5MP and 8MP handset lens capacity, we believe it is now in position to enjoy ASP and earnings growth underpinned by the industry's recent mass adoption of 8MP.

Display players benefit from bigger screen requirements

Truly (732 HK, Not Rated) produces flat panel display products. We expect Truly to enjoy higher ASPs as demand grows in China for larger smartphone panel sizes. IDC forecasts that the market share of smartphones with 5-inch and above screen sizes in China will exceed 20% by the end of 2013. As a result, smartphone makers have responded quickly with the release of a large number of smartphones with 5-inch and above screens. IDC data indicates that, as of 1Q13, the market share of 5-inch and above smartphones in China reached 7.5%, up 74% QoQ.

Tianma (000050 CH, Not Rated) specializes in the design, manufacture and supply of high-quality LCD and LCM products. Increasing demand for higher smartphone panel resolution and larger panel sizes will support growth at Tianma in 2013F.


16

From off-line retail channel to on-line e-purchases

Mobile internet and e-commerce in China has enjoyed robust growth driven by increasing broadband coverage and the popularity of smart devices such as smartphones and tablets. Sales channels for smartphones are shifting from off-line retail channels to on-line. One benefit of online retailers is that they tend to offer a wider range of payment options including credit or debit cards. Some also accept payments with PayPal and/or TenPal. Online channels offer an easy way to browse smartphones from different vendors using various OS. Some sites also offer comparison facilities. According to ZDC’s survey based on questionnaires from 1,400 internet users, 71.7% of respondents had purchased handsets through on-line retailers. The percentage rose 14.5% from the 57.2% level in 2011. Results from another survey, this time by iiMedia, revealed that 38.1% of respondents plan to purchase their next smartphone through the online channel. We believe the trend of making e-purchases will continue to gain popularity leading to rapid growth of the smart device market and mobile internet.

Online handset purchase experience Smartphone purchase plan by channel

36.9%

22.4% 20.3% 20.4%

59.8%

12.9% 12.0%15.4%

0%

10%

20%

30%

40%

50%

60%

70%

Both handset andhandset component

None of them Only handset Only handsetcomponent

2011 2013

30.7%

9.6%

24.2%

46.1%

33.4%

6.9%

38.1%

3.1%

7.5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Chainelectronic

stores

Megastore Salescounter

Telecomoperators

Specialitystores

Parallelimports

Onlinepurchase

Fromother

countries

Other

Source: ZDC Source: iiMedia

Xiaomi received mass media coverage since the launch of its flagship Phone, a low-cost smartphone in September 2011. Xiaomi also developed MIUI, custom firmware for mobile phones based on the Android OS. Xiaomi sells most of its smartphones online in small quantities. However, the company is now pinning its success on a combination high-quality and low‐priced products. Xiaomi sold 7.2m smartphones in 2012, with 70% of sales through the online channel. Leveraging its good brand recognition, the company launched 2A/2S early this year and more recently, its “Red Rice” product. It will launch its next-generation 4G LTE smartphone shortly, for now called the “MI-3”. Xiaomi can be best thought of as China’s answer to Apple based on its track record of innovation and superior product design. We believe the company will deliver 15-20m units in FY13F, which would be an increase of over 100% YoY.

TCL Communication has regained a lot of momentum this year. It launched a variety of smartphones, such as the giant screen quad-core Y900, as well as the ultra-thin dual-core S850 among others. In June 2003, TCL Communication and the E-retailer “Jingdong Mall” jointly launched “Idol X” (S950), a candy bar touch screen smartphone aimed at fashion-conscious consumers. TCL’s Idol X is equipped with a 5-inch large touch screen with a resolution of 1,080p full HD. It is TCL’s first 1080p screen smartphone and comes equipped with a quad-core processor and a 13MP pixel camera. It retails for a reasonable RMB1,699.


17

China smartphone model comparison

International brand Samsung Galaxy S4 iPhone 5 HTC One LG Optimus G Pro Sony Xperia Z BlackBerry Z10 Price (RMB) 5,799 6,088 3,900 2,950 3,510 3,200 Operating system Android OS iOS 6 Android OS Android OS Android OS BlackBerry OS 7 CPU Quad-Core Dual-Core Quad-Core Quad-Core Quad-Core Dual-Core Networks 4G/3G/2G 4G/3G/2G 4G/3G/2G 4G/3G/2G 4G/3G/2G 4G/3G/2G Screen size (inch) 5.0 4.0 4.7 5.5 5.0 4.2 Rear camera quality (MP) 13 8 4 13.2 13 8 Front camera quality (MP) 2 1.2 2.1 2.3 2.2 N/A Weight (g) 130 112 143 160 146 135 Dimensions 136.6 x 69.8 x 7.9mm 123.8 x 58.6 x 7.6mm 137.4 x 68.2 x 9.3mm 139 x 70 x 10mm 139 x 71 x 7.9mm 130 x 65.6 x 9mm Storage (GB) support microSD,

up to 64 GB 32GB 32GB support microSD,

up to 64 GB support microSD,

up to 32 GB 16GB, support

microSD Domestic brand – high end models Lenovo K900 ZTE Grand S Huawei Ascend D2 TCL idol X Coolpad 9960 Xiaomi M2 Price (RMB) 3,499 3,399 2,750 1,699 2,650 2,599 Operating system Android OS Android OS Android OS Android OS Android OS MIUI OS CPU Dual-Core Quad-Core Quad-Core Quad-Core Quad-Core Quad-Core Networks 3G / 2G 3G / 2G 3G / 2G 3G / 2G 3G / 2G 3G / 2G Screen size (inch) 5.5 5 5 5 4.7 4.3 Rear camera quality (MP) 13 13 13 13.1 13 8 Front camera quality (MP) 2 2 1.3 2 1.3 2 Weight (g) 162 110 170 120 158.5 145 Dimensions 157 x 78 x 6.9mm 142 x 70 x 6.9mm 140 x 71 x 9.4 mm 140.4 x 67.5 x

6.99mm 131 x 66 x 8.8mm 126 x 62 x 10.2mm

Storage (GB) 32 GB support microSD, up to 32 GB

32GB 16GB support microSD, up to 32 GB

32GB

Domestic brand – low end models Lenovo A820 ZTE U956 Huawei G520 TCL S900 Coolpad 7295 Xiaomi Red Rice Price (RMB) 770 910 820 800 900 799 Operating system Android OS Android OS Android OS Android OS Android OS MIUI OS CPU Quad-Core Quad-Core Quad-Core Dual-Core Quad-Core Quad-Core Networks 3G/2G 3G/2G 3G/2G 3G/2G 3G/2G 3G/2G Screen size (inch) 4.5 5 4.5 4.5 5 4.7 Rear camera quality (MP) 8 8 5 5 5 8 Front camera quality (MP) N/A 1 0.3 2 0.3 1.3 Weight (g) 144 138 150 141 133 158 Dimensions 135 x 68.2 x 9.9mm 132 x 65 x 9.8mm 134 x 66.8 x 9.9mm 132 x 70 x 9.5mm 140 x 73 x 9.9mm 137 x 69 x 9.9mm Storage (GB) support microSD,






up to 32 GB Source: www.ZOL.com


18

Hong Kong- and China-listed smartphone stocks price performance since 2012

Lenovo price performance since 2012 ZTE price performance since 2012

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

5.0

5.7

6.4

7.1

7.8

8.5

9.2

Jan-12 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13

HK$

Lenovo (LHS) HSCEI (RHS)

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

9

11

13

15

17

19

21

23

25


HK$

ZTE (LHS) HSCEI (RHS) Source: Bloomberg Source: Bloomberg

AAC price performance since 2012 Sunny Optical price performance since 2012

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

16

20

24

28

32

36

40

44

48


HK$

AAC (LHS) HSCEI (RHS)

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

1

2

3

4

5

6

7

8

9

10

11

12


HK$

Sunny Optical (LHS) HSCEI (RHS) Source: Bloomberg Source: Bloomberg

TCL Communication price performance since 2012 China Wireless price performance since 2012

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

1.5

2.0

2.5

3.0

3.5

4.0

4.5


HK$

TCL (LHS) HSCEI (RHS)

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

1.0

1.5

2.0

2.5

3.0

3.5

4.0


HK$

China Wireless (LHS) HSCEI Source: Bloomberg Source: Bloomberg

TCL Communication (2618 HK) 7 August 2013

19

TCL Communication (2618 HK)

A turnaround story Company Rating:

Outperform (initiation)

Initiate with Outperform and HK$4.50 target price. We initiate coverage on TCL Communication (2618 HK) with an Outperform rating and target price of HK$4.50, based on 12x FY14F P/E. We like TCL's overseas exposure, its fast-fashion product development strategy and its improving smartphone model line-up.

Fast-fashion the key to future success. Following the return of Chief Marketing Officer, Mr. Dan Dery, TCL Communication adopted a fast-fashion approach to design with the trendy and colorful “One Touch” series – the “Idol Ultra” and “Idol X” launched this year. These products were well received by the market and we believe the company is now on track to regain smartphone sales momentum in FY13F and FY14F.

Alcatel brand vital to overseas penetration. While the TCL brand mainly targets the domestic market, the “Alcatel” brand acquired in 2005 is aimed at the overseas market. Unlike local rivals Lenovo, Coolpad. Huawei and ZTE, we believe TCL’s dual-brand strategy holds the key to its success in overseas markets because of the company’s better brand recognition and effective distribution channels.

Strong smartphone sales to support margin recovery. TCL Communication was slow in new product development during the early stages of smartphone adoption in FY11 and FY12, but it recently stepped up efforts to improve the design of its products beginning with the popular One Touch series mid-end smartphone. With its dual-brand strategy, we believe smartphone unit sales will top 15m/25m in FY13F/14F, with a much higher blended ASP/GPM.

Forecasts and valuation Year to 31 December 2011 2012 2013F 2014F 2015F Revenue (HK$m) 10,653 12,031 17,925 24,700 30,225 Net profit (HK$m) 800 (208) (43) 422 602 EPS (HK$) 0.70 (0.18) (0.04) 0.37 0.53 YoY change (%) 11.8 N/A (78.8) N/A 42.5 DPS (HKD cents) 29.20 3.01 0.00 13.09 18.66 Dividend yield (%) 8.8 0.9 0.0 3.9 5.6 P/E (x) 4.7 N/A N/A 8.9 6.2 P/B (x) 1.4 1.6 1.7 1.4 1.2 ROE (%) 29.9 (8.9) (1.9) 15.8 19.2 Source: Company data, CCBIS estimates

Price: HK$3.33 Target: HK$4.50 (initiation) Trading data 52-week range HK$1.60-4.51 Market capitalization (m) HK$3,829/US$489 Shares outstanding (m) 1,150 Free float (%) 43.0 3M average daily T/O (m share) 5.4 3M average daily T/O (US$m) 2.3 Expected return (%) – 1 year 35.1 Price as at close on 7 August 2013

Stock price vs. HSCEI

1

2

3

4

5

6

7

8

9

10

Jan-10 Sep-10 Jun-11 Feb-12 Nov-12 Aug-13

HK$

TCL HSCEI (rebased) Source: Bloomberg





20

TCL Communication – financial summary

Income statement Balance sheet

FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F Revenue 10,653 12,031 17,925 24,700 30,225 Cost of revenue (8,325) (9,935) (14,743) (19,982) (24,452) Gross profit 2,328 2,097 3,182 4,718 5,773 Other income and gains 313 329 366 473 557 Selling and distribution expenses (866) (1,154) (1,613) (2,174) (2,630) Administrative expenses (558) (658) (896) (1,235) (1,511) R&D costs (459) (740) (1,076) (1,309) (1,511) Other expenses (28) (109) (18) (25) (30) Operating profit 729 (234) (55) 448 648 Net interest income 55 47 10 10 5 Share of result of jointly controlled entities/associates

(1) (2) (2) 0 0

Other 0 0 0 0 0 Profit before tax 783 (188) (47) 458 653 Tax expense 17 (32) 3 (27) (39) Minority interest (1) 12 1 (9) (12) Profit to shareholders 800 (208) (43) 422 602 EPS (HK$) 0.70 (0.18) (0.04) 0.37 0.53 Handset shipments (m unit) 43.6 42.6 50.0 55.0 57.5

FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F Cash and bank balances 1,187 970 1,146 796 1,174 Pledged bank deposits 6,092 4,221 3,666 3,666 3,166 Trade and bills receivables 2,638 2,882 3,496 4,795 5,855 Prepayments, deposits and other assets 870 1,246 1,857 2,559 3,131 Inventories 981 1,263 2,020 2,737 3,350 Other current assets 485 630 459 459 459 Current assets 12,254 11,212 12,644 15,013 17,136 Property, plant and equipment 497 597 829 938 1,030 Goodwill 254 254 254 254 254 Prepaid lease payments 185 177 176 176 176 Intangible assets 702 921 662 749 820 Investment in jointly controlled entities/ associates

2 4 2 2 2

Other non-current assets 132 157 157 157 157 Total non-current assets 1,773 2,109 2,081 2,277 2,439 Accounts and bills payable 1,952 2,429 3,231 4,380 5,359 Other payables and accruals 1,431 1,620 2,414 3,327 4,071 Short-term bank loans 7,222 5,726 5,726 5,726 5,726 Other current liabilities 710 830 638 711 806 Total current liabilities 11,315 10,606 12,010 14,144 15,963 Long-term bank loans 0 194 388 388 388 Other non-current liabilities 39 199 82 82 82 Total non-current liabilities 39 393 471 471 471 Shareholders’ equity 2,669 2,321 2,244 2,666 3,120 Minority interest 4 2 1 9 22 Total equity 2,673 2,323 2,245 2,675 3,142

Cash flow Financial ratios

FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F Profit before tax 783 (188) (47) 458 653 Depreciation and amortization 107 142 175 215 247 Change in working capital (722) (102) (524) (585) (425) Other (47) 373 316 (72) (79) Operating cash flow 122 224 (80) 15 396 Capex (232) (246) (350) (250) (250) Other (734) (805) (110) (115) (120) Investment cash flow (966) (1,052) (460) (365) (370) Change in borrowings 735 (1,302) 194 0 0 Other (99) 1,942 521 0 352 Financing cash flow 637 640 715 0 352 Change in cash (207) (187) 176 (350) 378 Exchange losses on cash and cash equivalents

49 (30) 0 0 0

Cash, beginning 1,345 1,187 970 1,146 796 Cash, ending 1,187 970 1,146 796 1,174

FYE 31 December (%) 2011 2012 2013F 2014F 2015F Profitability Gross margin 21.9 17.4 17.8 19.1 19.1 Operating margin 6.8 (1.9) (0.3) 1.8 2.1 Net margin 7.5 (1.7) (0.2) 1.7 2.0 ROE 29.9 (8.9) (1.9) 15.8 19.2 Growth Sales revenue growth 22.4 12.9 49.0 37.8 22.4 Operating income growth 19.5 (9.9) 51.8 48.3 22.4 Net profit growth 14.0 N/A N/A N/A 42.5 EPS growth 11.8 N/A (78.8) N/A 42.5 Liquidity Net debt/equity (%) Net cash 31.4 58.0 61.7 56.5

Source: Historical data from the Company, forecasts by CCBIS


21

Initiate with Outperform and HK$4.50 target price

We initiate coverage on TCL Communication with an Outperform rating and target price of HK$4.50 based on 12x FY14F P/E. We like TCL’s overseas exposure, renewed fast-fashion product development strategy, and improving smartphone model line-up.

TCL Communication – YTD price performance versus Hang Seng Index

TCL Communication – 5-year forward P/B bands

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

1.5

2.0

2.5

3.0

3.5

4.0

4.5


HK$

TCL (LHS) HSCEI (RHS)

Mean

+1s.d.

-1s.d.

+2s.d.

0.0x

0.4x

0.8x

1.2x

1.6x

2.0x

2.4x

2.8x

3.2x

3.6x

4.0x

Jul-08 Mar-09 Dec-09 Sep-10 May-11 Feb-12 Nov-12 Aug-13 Source: Bloomberg Source: Bloomberg

Fast-fashion design and better overseas exposure vital for turnaround. Following the return of Chief Marketing Officer, Mr. Dan Dery, TCL Communication adopted a fast-fashion design approach to its business, beginning with the launch of the trendy “One Touch Series”, including the new products, “Idol Ultra” and “Idol X”. These were well-received by consumers and have put the company on track to regain smartphone sales momentum in FY13F and FY14F. Unlike domestic rivals, Lenovo, Coolpad, Huawei and ZTE, which rely on a single brand to market their goods, TCL Communication adheres to a duel-brand strategy, with the TCL brand used to market the company’s products in the domestic market and the Alcatel brand used to tackle the overseas market. Alcatel was formerly a French brand until it was acquired in by TCL Communication in 2005. We believe the TCL/Alcatel dual-brand strategy will be a big plus for TCL Communication’s success in its overseas markets because Alcatel is already a well-known brand in Europe and North America; moreover, TCL Communication can avail itself of Alcatel’s existing distribution channels. In our view, TCL Communication’s duel-brand strategy puts it on track to regain smartphone sales momentum in FY13F and FY14F.

Higher smartphone sales to support margin recovery. In its early stages, TCL Communication had been slow in new product development. Lately, however, it has stepped up efforts with a new model roll-out which included the introduction of a few trendy and colorful mid-end smartphones, the One Touch Idol Series. We believe the latest new model line-up (Idol Ultra and Idol X) along with the effective dual-brand (Alcatel & TCL) strategy will support 15m/25m unit sales in FY13F/14F. With improving blended ASP from stronger mid-end smartphone sales and better economies of scale, we expect gross profit margin for the company to reach 19.1% in FY14F versus 17.4% in FY12.

Risks: (1) Intense price competition from other local rivals, (2) increasing cost from R&D/marketing expenses, and (3) slower-than-expected sales recovery from overseas markets.


22

Company background

TCL Communication Technology Holdings Limited (“TCL”) is a member company of TCL Corporation. It listed on the Hong Kong Stock Exchange in 2004. TCL is a China-based, international handset vendor that designs, manufactures and markets its portfolio of products under two separate brand names: “TCL” and “Alcatel”, the brand associated with the “One Touch” suite of smartphones. The former targets the domestic market and the latter is TCL Communication’s overseas brand. The company launched its first 3G Android smartphone, the OT-980, in September 2010. Nearly 90% of its handsets are shipped overseas.

In 2004, TCL Communication established TCL & Alcatel Mobile Phones Limited (“T&A”), a joint venture with Alcatel. In 2005, TCL Communication acquired from Alcatel the remaining stake in T&A, with the new entity becoming a wholly owned subsidiary of TCL Communication. TCL Communication later signed a license agreement with Alcatel Lucent in 2004 to use the Alcatel brand for an initial term of ten years. In September 2011, an amended license agreement was signed between TCL Communication and the Alcatel Lucent that extended their range of products to include not only mobile handsets but also tablets. The revised term for the amended license agreement is from July 2011 to December 2024.

Shareholding structure

TCL Corporation, the largest shareholder in TCL Communication, owned a 50.2% stake in the company, while public shareholders own approximately 43%.

TCL Communication – shareholding structure

TCL Corp50.2%

LI Dong Sheng & LEUNG Lai Bing

6.9%

Other43.0%

Source: Company data

R&D investment and production plan

Headquartered in Shenzhen, the production facilities and R&D centers of the Group is located in Huizhou and various provinces of China respectively with over 2,000 experienced research engineers, and various technological patents. This has enabled TCL to consolidate its leadership in the low-end handset market, further penetrate the mid-to-high end market and optimize its product mix with its “Step-up” product strategy.


23

In 2012, TCL successfully carried out a product transition from feature phones to smartphones while consolidating its product portfolio, paving the way for further expansion and long-term success. The company achieved several breakthroughs in the development of new smartphone products and made good progress increasing overall smartphone sales volume in 2012. In 1H13, a new wave of advanced smartphones was launched with features including 4.5”-5.0” displays, quad-core, and ultra-slim designs. TCL‘s Idol X, one of the company’s flagship products in 2013, was snatched up by customers on its presale in China on 18 June this year.

TCL will be moving into a new production plant in Huizhou in September 2013, in the process adding an extra 30m units of capacity. Production costs are expected to decline with the increase in production scale, leading to higher margins.

TCL Communication’s new production plant in Huizhou, China

Source: Company

TCL has developed a comprehensive distribution network covering over 40 telecom operators and distributors worldwide. Its products are selling in over 120 countries throughout the Americas, Europe, the Middle East, Africa and Asia Pacific. TCL will continue expanding its global customer base and distribution network by strengthening its partnerships with major telecommunication operators worldwide.

TCL’s partnerships with worldwide telecommunication operators

Source: Company


24

Financial summary

On the back of TCL’s stronger smartphone design capabilities which have led to a new model roll-out that includes the mid-end smartphone, we forecast a slight net loss of HK$43.3m for FY13F, improving from the net loss of HK$207.8m in FY12. We attribute the improvement to better blended ASP and gross profit margin.

TCL Communication – financial summary

(4)%

0%

4%

8%

12%

16%

20%

24%

0

4,000

8,000

12,000

16,000

20,000

24,000

28,000

32,000

FY11 FY12 FY13F FY14F FY15F

HK$m

Sales (LHS) Gross profit margin (RHS) Operating margin (RHS) Net profit margin (RHS) Source: Company data, CCBIS estimates

Impressive sales growth. We forecast sales revenue will grow 49.0% YoY in FY13F and 37.8% YoY in FY14F thanks to the company’s new smartphone model line-up and deeper penetration into overseas markets. The first wave of mid-range smartphones was launched in China and overseas in 1QFY13 and 2QFY13 respectively as planned. Meanwhile, TCL has already kicked off the R&D projects for its second wave of smartphones, with more advanced products featuring full HD displays and LTEs, which will be launched in 2H FY13 as an extension of the first-wave of products.

Improving gross profit margin. We estimate gross profit margin will climb steadily from 17.4% in FY12 to 17.8%/19.1% in FY13F/14F, thanks to the company’s “Step-up” strategy of moving from low-end smartphones towards mid- to high-end smartphones. This strategy will support higher blended ASP and gross margin. Better economies of scale and tighter cost-controls are also likely to improve gross margins.

Falling opex/sales ratio. We expect the operating expense-over-sales ratio to decline slightly, from 22.1% in FY12 to 20.1%/19.2% in FY13F/14F, driven by the company’s improving R&D process for smartphones. In addition, TCL has plans to optimize its organizational structure and business processes in order to improve overall operational efficiency.

ROE and net debt position. We believe TCL will be one of the fastest growing smartphone vendors in the industry with a favorable ROE of 15.8% in FY14F, though the company is likely to be in a net debt position in both FY13F and FY14F, in our view.

Expanded production capacity. Upon moving to its new production plant in September 2013, TCL’s production capacity will reach 100m-120m units per year.


25

TCL Communication – income statement

FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F 1Q13 2Q13F 3Q13F 4Q13F Revenue 10,653 12,031 17,925 24,700 30,225 2,449 4,030 5,148 6,298 Cost of revenue (8,325) (9,935) (14,743) (19,982) (24,452) (2,046) (3,325) (4,222) (5,150) Gross profit 2,328 2,097 3,182 4,718 5,773 402 705 927 1,147 Gross profit margin 21.9 17.4 17.8 19.1 19.1 16.4 17.5 18.0 18.2 Other income and gains 313 329 366 473 557 56 80 90 140 Selling and distribution expense (866) (1,154) (1,613) (2,174) (2,630) (289) (363) (463) (498) Administrative expense (558) (658) (896) (1,235) (1,511) (188) (202) (257) (250) R&D costs (459) (740) (1,076) (1,309) (1,511) (224) (242) (257) (352) Other expenses (28) (109) (18) (25) (30) (5) (4) (5) (4) Operating profit 729 (234) (55) 448 648 (247) (25) 33 183 Operating margin 6.8 (1.9) (0.3) 1.8 2.1 (10.1) (0.6) 0.6 2.9 Net interest income 55 47 10 10 5 6 5 0 (1) Share of result of jointly controlled entities/associates (1) (2) (2) 0 0 (0) (1) (1) (1) Other 0 0 0 0 0 0 0 0 0 Profit before tax 783 (188) (47) 458 653 (241) (20) 33 182 Tax expense 17 (32) 3 (27) (39) (6) 1 (2) 10 Minority interest (1) 12 1 (9) (12) 1 0 (1) (0) Profit to shareholders 800 (208) (43) 422 602 (246) (19) 30 191 Net profit margin 7.5 (1.7) (0.2) 1.7 2.0 (10.1) (0.5) 0.6 3.0 EPS (HK$) 0.70 (0.18) (0.04) 0.37 0.53 (0.22) (0.02) 0.03 0.17 EPS growth (%) 11.8 N/A (78.8) N/A 42.5 (641.8) (124.3) (135.5) (179.3) Gross profit margin (%) 21.9 17.4 17.8 19.1 19.1 16.4 17.5 18.0 18.2 Operating profit margin (%) 6.8 (1.9) (0.3) 1.8 2.1 (10.1) (0.6) 0.6 2.9 Net profit margin (%) 7.5 (1.7) (0.2) 1.7 2.0 (10.1) (0.5) 0.6 3.0 ROE (%) 29.9 (8.9) (1.9) 15.8 19.2 Net debt/equity (%) Net cash 31.4 58.0 61.7 56.5 Source: Historical data from the Company, forecasts by CCBIS

China Wireless (2369 HK) 7 August 2013

26

China Wireless (2369 HK)

In the sweet spot Company Rating:

Outperform (initiation)

Initiate with Outperform and HK$3.40 target price. We initiate coverage on China Wireless (2369 HK) with a target price of HK$3.40 based on 12x FY14F P/E. We like China Wireless because of its (1) strong ties with local operators, (2) improving economies of scale, and (3) good traction with overseas telecom operators.

Strong ties with leading Chinese telecom operators a big plus. Over 90% of Coolpad-brand smartphone sales were to top-three Chinese telecom operators in FY11/12. China Wireless has strong ties with local telecom operators and improving product development capabilities. The company is well positioned to benefit from increasing handset subsidies from both China Mobile and China Telecom as well as from surging 4G handset demand.

Overseas market expansion in the works. The Coolpad brand has been doing well on home soil thanks to its strong ties with China telecom operators. It has recently beefed up efforts to court telecom operators in developed markets. In light of its improving product development capabilities and experience dealing with overseas telecom operators, we look for China Wireless to deliver 2.0m/4.0m smartphones to US and EU telecom operators in FY13F and FY14F, equivalent to 11.3% and 15.5%, respectively, of total sales revenue.

Solid sales growth with stable profit margin. Taking advantage of opportunities at home and traction overseas, we forecast 52% unit sales growth in FY13F and 25% in FY14F. We remain confident that the improving sales mix towards 4G smartphones together with greater overseas exposure will support stable gross profit margin of 12% for FY13F and FY14F.

Forecasts and valuation Year to 31 December 2011 2012 2013F 2014F 2015F Revenue (HK$m) 7,340 14,359 20,640 26,832 33,540 Net profit (HK$m) 271 326 482 607 761 EPS (HK$) 0.12 0.15 0.22 0.28 0.35 YoY change (%) (45.3) 24.4 48.1 25.8 25.4 DPS (HKD cents) 2.89 2.92 6.72 8.45 10.60 Dividend yield (%) 1.1 1.1 2.6 3.3 4.1 P/E (x) 21.3 17.1 11.6 9.2 7.3 P/B (x) 2.6 2.3 2.0 1.7 1.5 ROE (%) 12.4 13.5 17.3 18.7 20.0 Source: Company data, CCBIS estimates

Price: HK$2.59 Target: HK$3.40 (initiation) Trading data 52-week range HK$1.17-3.92 Market capitalization (m) HK$5,576/US$701 Shares outstanding (m) 2,153 Free float (%) 60.5 3M average daily T/O (m share) 17.6 3M average daily T/O (US$m) 5.8 Expected return (%) – 1 year 31.2 Price as at close on 7 August 2013


0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

3.5x

4.0x

4.5x

5.0x

5.5x

6.0x


HK$

China Wireless HSCEI (rebased) Source: Bloomberg





27

China Wireless – financial summary


FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F Revenue 7,340 14,359 20,640 26,832 33,540 Cost of revenue (6,259) (12,639) (18,163) (23,612) (29,515) Gross profit 1,081 1,720 2,477 3,220 4,025 Other income and gains 289 259 250 250 250 Selling and distribution expenses (466) (870) (1,259) (1,610) (1,979) Administrative expenses (559) (674) (888) (1,127) (1,375) Other expenses (5) (18) (21) (27) (34) Operating profit 340 418 560 706 887 Net interest income (15) 6 6 6 6 Share of result of associates (0) 1 1 1 1 Share of result of jointly controlled entities

0 (7) 0 0 0

Profit before tax 324 418 567 713 894 Tax expense (53) (94) (85) (107) (134) Minority interest 0 1 1 1 1 Profit to shareholders 271 326 482 607 761 EPS (HK$) 0.12 0.15 0.22 0.28 0.35

FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F Cash and bank balances 1,059 1,274 1,444 1,732 2,164 Pledged time deposits 1,080 710 710 710 710 Trade and bills receivables 2,257 2,416 3,473 4,515 5,644 Prepayments, deposits and other assets 314 648 778 934 1,121 Inventories 1,669 1,811 2,603 3,384 4,230 Other current assets 1 0 0 0 0 Current assets 6,380 6,859 9,007 11,274 13,868 Property, plant and equipment 527 537 688 826 951 Investment properties 335 310 310 310 310 Prepaid land lease payments 110 125 125 125 125 Intangible assets 112 161 142 116 85 Investment in jointly controlled entities 0 7 7 7 7 Investment in associates 35 53 53 53 53 Available-for-sale investments 11 24 24 24 24 Other non-current assets 21 28 28 28 28 Total non-current assets 1,152 1,244 1,377 1,490 1,583

Accounts and bills payable 2,993 3,823 5,494 7,143 8,928 Other payables and accruals 982 1,170 1,404 1,685 2,022 Interest-bearing bank borrowings 1,190 536 536 536 536 Other current liabilities 33 63 63 63 63 Total current liabilities 5,198 5,592 7,497 9,427 11,549 Total non-current liabilities 143 99 99 99 99 Shareholders’ equity 2,185 2,410 2,786 3,236 3,801 Minority interest 5 3 3 2 2 Total equity 2,190 2,413 2,788 3,239 3,803


FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F Profit before tax 324 418 567 713 894 Depreciation and amortization 73 115 128 147 167 Change in working capital (366) 322 (73) (49) (39) Other (2) 57 (92) (114) (141) Operating cash flow 29 912 530 697 881 Capex (78) (109) (200) (200) (200) Other (374) 299 2 2 2 Investment cash flow (452) 190 (198) (198) (198) Change in borrowings 491 (702) 0 0 0 Other 313 (184) (161) (211) (251) Financing cash flow 805 (886) (161) (211) (251) Change in cash 382 216 170 288 432 Exchange losses on cash and cash equivalents

35 (2) 0 0 0

Cash, beginning 642 1,059 1,274 1,444 1,732 Cash, ending 1,059 1,274 1,444 1,732 2,164

FYE 31 December (%) 2011 2012 2013F 2014F 2015F Profitability Gross margin 14.7 12.0 12.0 12.0 12.0 Operating margin 4.6 2.9 2.7 2.6 2.6 Net margin 3.7 2.3 2.3 2.3 2.3 ROE 12.4 13.5 17.3 18.7 20.0 Growth Sales revenue growth 59.8 95.6 43.7 30.0 25.0 Operating income growth (37.5) 23.0 33.9 26.2 25.6 Net profit growth (43.5) 20.0 48.1 25.8 25.4 EPS growth (45.3) 24.4 48.1 25.8 25.4 Liquidity Net debt/equity (%) Net cash Net cash Net cash Net cash Net cash



28

Initiated with Outperform and HK$3.40 target price

We initiate coverage on China Wireless (2369 HK, Outperform) with a target price of HK$3.40, based on 12x FY14F P/E. Despite intense competition within the China smartphone space, we like China Wireless and its smartphone brand, “Coolpad”, because of (1) its strong ties with leading China telecom operators, (2) robust unit sales growth with improving economies of scale, and (3) its progress penetrating leading telecom operators in the US and the EU.

China Wireless – YTD price performance vs. HSI China Wireless – 5-year forward P/E bands

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

1.0

1.5

2.0

2.5

3.0

3.5

4.0


HK$

China Wireless (LHS) HSCEI

Mean

+1s.d.

-1s.d.

+2s.d.

0x

4x

8x

12x

16x

20x

24x

28x

32x

36x

40x

44x

Jul-08 Feb-09 Oct-09 May-10 Jan-11 Sep-11 Apr-12 Dec-12 Jul-13 Source: Bloomberg Source: Bloomberg

Benefiting from increasing handset subsidies from leading China telecom operators. Over the years, over 90% of “Coolpad” brand smartphone sales were made in China because of China Wireless’ strong ties with leading Chinese telecom operators together with its outstanding product development capabilities. With increasing handset subsidies from both China Mobile (941 HK, Not Rated) and China Telecom (728 HK, Not Rated) and surging 4G smartphone demand, we believe China Wireless will enjoy robust unit sales growth of 48.5%/20.0 for FY13F/14F, given the company’s home-court advantage.

On-track overseas market expansion. China Wireless has been performing well in its backyard owing to its strong ties with Chinese telecom operators. The company is now pursuing business opportunities with leading telecom operators in developed countries. In light of its improving R&D capabilities and experience dealing with overseas telecom operators, we anticipate China Wireless will ship 2.0m/4.0m smartphones to US and EU telecom operators in FY13F/14F, representing 11.3%/15.5% of the company’s total sales revenue. Although sales contribution from overseas markets is still relatively small, we believe higher blended ASP and better overall margins will be positive to the company’s profit growth in FY14F/15F.

Risks: (1) Intense price competition from the China smartphone OEMs, (2) the increasing cost of manufacturing, (3) slower-than-expected 4G adoption in China.


29

Company background

China Wireless Technologies Limited (“China Wireless”) was incorporated in 2002 and listed on the Hong Kong Stock Exchange in 2004. Yulong Computer Telecommunication Scientific (Shenzhen) Company Limited (“Yulong”) is a wholly owned subsidiary of China Wireless, mainly engaged in the development and manufacture of Coolpad smartphone sets, the mobile data platform system, and value-added business operations in China. The key product of the company is its 3G smartphone launched under its “CoolPad” brand. The sales of CoolPad 3G smartphones covered regions across China and has already expanded into overseas markets including India, Taiwan and Indonesia.

As a local brand in China, the company not only sells smartphones through its carriers’ channels, but it is also forging relationships with its e-commerce partners as a way to reap the benefits offered by the various e-commerce channels. According to a SINO-MR report, Coolpad smartphones had the fourth-largest market share of the China 3G smartphone market in 2012.

Meanwhile, China Wireless has succeeded in breaking into the global telecommunications market by leveraging its growing brand recognition within the global smartphone market. Apart from its existing markets in India and Taiwan, China Wireless also penetrated the North American 4G smartphone market in 2012. China Wireless plans to enter the European market in 2013.


Mr. Guo Deying, the executive director of the company, and his spouse, Ms. Yang Xiao, the non-executive director, co-own 39.5% of China Wireless. Public shareholders own approximately 60.5% of the company.

China Wireless – shareholding structure

Mr. Guo Deying &Ms. Yang Xiao

39.5%

Other60.5%

Source: Company data


30

R&D capability and product development

In 2007, China Wireless received a national award from China’s State Council for its “double network” technology, which simultaneously connects cell phones to both the CDMA and GSM networks. Some models of Coolpad phones also have settings for heightened privacy protection. As a result, Coolpad phones are favored by, and are purchased as, gifts for businessmen and government officials in China.

In 2012, China Wireless launched a full range of Coolpad smartphones from high-end to mid-end and low-end versions, offering users better quality and better radio performance. The company also successfully rolled out products covering 3G and 4G network smartphones. For EVDO-based smartphones, the Group launched 18 new models. For TD-SCDMA-based smartphones, the Group launched 17 new models. For WCDMA-based smartphones, the Group launched 13 new models. The company also started to launch 4G FDD-LTE smartphones, which were exported to the North American market.

By differentiating the functions and features of the Android operating system, and by providing the special Coollife UI4.1 user interface on the new models, the Coolpad smartphones became more competitive and more attractive. The company upgraded to the latest Android operating system version, the so-called “Jelly Bean”, running on the famous Coolpad DNA, entailing dual-mode, dual-standby technology combining two disparate radio technologies, private mode guaranteeing the security of the users’ private data, and Chinese-language handwriting recognition software allowing users to input more conveniently. The Coolcloud platform was also upgraded to the latest Coolcloud 3.0 version, which made data synchronization of smartphones work faster and more effectively once users switched to the new Coolpad smartphones. Apart from the synchronization function, Coolpad users could also use the anti-theft, antivirus and other features of the phone. Security features come with Coolcloud to ensure data is not leaked.

China Wireless manufactures all its Coolpad smartphones in-house. It has six R&D facilities worldwide.

Global R&D centers

Source: Company


31

Financial summary

We forecast net income of China Wireless will rise 48.1%/25.8% YoY to HK$482m/HK$606.6m in FY13F/14F, thanks to the company’s strong ties with Chinese telecom operators and due to the encouraging progress of its overseas expansion.


2%3%4%5%6%7%8%9%10%11%12%13%14%15%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000


HK$m


Impressive sales growth. We expect the company’s sales revenue to rise 43.7% YoY in FY13F and 30.0% YoY in FY14F, driven by the flourishing 3G mobile market in China and the 4G mobile market in overseas.

Improving gross profit margin. Despite stiff competition within the smartphone market in China, we believe China Wireless will be capable of maintaining its gross profit margin at 12% in FY13F/14F based on its improving product mix with a higher proportion of 4G smartphones contributing 10%/25% of total smartphone unit shipments in FY13F/14F, up from merely 4.8% in FY12.

Falling opex/sales ratio. We expect the operating expenses-over-sales ratio to improve from 10.9% in FY12 to 10.5%/10.3% in FY13F/14F, as the company benefits from improving economies of scale and tight cost controls.

ROE and net cash position. We see strong growth momentum for China Wireless and expect favorable ROE of 17.3%/18.7% and, ultimtely, a net cash position in FY13F/14F.

Expanding production capacity. China Wireless’ Dongguan production plant has annual production capacity of 30m units. With the company’s annual sales target of approximately 32m units in FY13F, the production plant will soon reach full utilization. China Wireless plans to expand its annual production capacity to 35m units by the end of FY13 with capex of HK$200m.


32

China Wireless – income statement

FYE 31 December (HK$m) 2011 2012 2013F 2014F 2015F 1H12 2H12 1H13F 2H13F Revenue 7,340 14,359 20,640 26,832 33,540 6,218 8,141 8,772 11,868 Cost of revenue (6,259) (12,639) (18,163) (23,612) (29,515) (5,474) (7,165) (7,719) (10,444) Gross profit 1,081 1,720 2,477 3,220 4,025 744 976 1,053 1,424 Gross profit margin 14.7 12.0 12.0 12.0 12.0 12.0 12.0 12.0 12.0 Other income and gains 289 259 250 250 250 73 187 100 150 Selling and distribution expense (466) (870) (1,259) (1,610) (1,979) (254) (615) (535) (724) Administrative expense (559) (674) (888) (1,127) (1,375) (372) (302) (360) (528) Other expenses (5) (18) (21) (27) (34) (5) (13) (9) (12) Operating profit 340 418 560 706 887 186 232 249 310 Operating margin 4.6 2.9 2.7 2.6 2.6 3.0 2.9 2.8 2.6 Net interest income (15) 6 6 6 6 (8) 14 (10) 16 Share of result of associates (0) 1 1 1 1 0 0 0 1 Share of result of jointly controlled entities 0 (7) 0 0 0 0 (7) 0 0 Profit before tax 324 418 567 713 894 178 240 239 327 Tax expense (53) (94) (85) (107) (134) (26) (68) (36) (49) Minority interest 0 1 1 1 1 0 1 0 0 Profit to shareholders 271 326 482 607 761 153 173 204 278 Net profit margin 3.7 2.3 2.3 2.3 2.3 2.5 2.1 2.3 2.3 EPS (HK$) 0.12 0.15 0.22 0.28 0.35 0.07 0.08 0.09 0.13 EPS growth (%) (45.3) 24.4 48.1 25.8 25.4 35.1 20.7 34.8 60.8 Gross profit margin (%) 14.7 12.0 12.0 12.0 12.0 12.0 12.0 12.0 12.0 Operating profit margin (%) 4.6 2.9 2.7 2.6 2.6 3.0 2.9 2.8 2.6 Net profit margin (%) 3.7 2.3 2.3 2.3 2.3 2.5 2.1 2.3 2.3 ROE (%) 12.4 13.5 17.3 18.7 20.0 Net debt/equity (%) Net cash Net cash Net cash Net cash Net cash Source: Historical data from the Company, forecasts by CCBIS

Sunny Optical (2382 HK) 7 August 2013

33

Sunny Optical (2382 HK)

Benefiting from camera pixel migration Company Rating:

Neutral (initiation)

Initiate with Neutral and HK$8.70 target price. We initiate coverage on Sunny Optical (2382 HK) with a Neutral rating and HK$8.70 target price based on 12x FY14F P/E. Sunny Optical is well positioned to take advantage of the current handset camera pixel migration. We also like its dominant market share among the leading China smartphone brands. That said, we believe the stock’s year-to-date price performance already reflects these positives.

To benefit from smartphone camera pixel migration. Sunny Optical is one of China’s leading handset camera module manufacturers with over 50% market share of Chinese smartphone brands. Camera pixel migration from 5MP to 8MP/13MP and robust unit sales growth in China will hold the company in good stead. We forecast handset camera-related sales will grow 71.3% in FY13F and 47.1% YoY in FY14F.

Vehicle lenses the wild card. Besides the company’s conventional handset-related camera business, lucrative revenue opportunities from automobile cameras exist owing to the rapid adoption of rear and front parking cameras. Although we forecast sales contribution of merely 4% in FY13F and FY14F, sales growth will top 40% with above-company-average gross profit margin of 40%.

Impressive sales growth but gross profit under pressure. We estimate sales revenue growth will top 47.4%/36.3% YoY in FY13F/14F owing to the impressive performance of the handset division. Blended gross profit margin will decline 120bp/70bp to 17.4%/16.7% in FY13F/14F on a higher sales mix toward lower margin handset camera modules and intense price competition from local rivals.

Forecasts and valuation Year to 31 December 2011 2012 2013F 2014F 2015F Revenue (RMB m) 2,499 3,984 5,872 8,004 9,740 Net profit (RMB m) 215 346 446 564 660 EPS (RMB) 0.22 0.35 0.45 0.57 0.67 YoY change (%) 51.0 60.1 28.5 25.9 16.7 DPS (RMB cents) 7.29 10.73 13.64 17.18 20.04 Dividend yield (%) 1.0 1.6 2.0 2.6 3.1 P/E (x) 31.7 19.3 14.7 11.5 9.7 P/B (x) 4.8 4.2 3.6 3.1 2.6 ROE (%) 12.8 17.9 19.7 21.0 20.9 Source: Company data, CCBIS estimates

Price: HK$8.34 Target: HK$8.70 (initiation) Trading data 52-week range HK$2.99-11.78 Market capitalization (m) HK$8,160/US$1,072 Shares outstanding (m) 978 Free float (%) 57.9 3M average daily T/O (m share) 9.5 3M average daily T/O (US$m) 10.2 Expected return (%) – 1 year 4.3 Price as at close on 7 August 2013


0

2

4

6

8

10

12


HK$

Sunny Optical HSCEI (rebased) Source: Bloomberg





34

Sunny Optical – financial summary


FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Revenue 2,499 3,984 5,872 8,004 9,740 Cost of revenue (1,976) (3,243) (4,850) (6,668) (8,133) Gross profit 523 741 1,022 1,337 1,607 Other income and gains 54 36 50 50 50 Selling and distribution expense (59) (64) (95) (120) (146) R&D expense (131) (163) (241) (320) (390) Administrative expense (123) (150) (221) (296) (360) Operating profit 264 399 515 650 761 Net interest income 6 7 5 5 5 Share of result of associates (4) (4) (5) (5) (5) Other (26) (5) 0 0 0 Profit before tax 240 397 515 650 761 Tax expense (38) (58) (77) (98) (114) Minority interest 14 7 9 11 13 Profit to shareholders 215 346 446 564 660 EPS (RMB) 0.22 0.35 0.45 0.57 0.67 EPS (HK$) 0.26 0.43 0.57 0.72 0.86

FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Cash and bank balances 252 243 130 45 120 Trade & bills receivables 570 742 1,107 1,487 1,796 Prepayments, deposits and other assets 57 159 234 319 389 Inventories 472 748 1,129 1,553 1,894 Other current assets 471 375 375 375 375 Current assets 1,822 2,267 2,976 3,779 4,573 Property, plant and equipment 489 646 808 940 1,042 Prepaid lease payments 18 23 23 23 23 Intangible assets 0 0 (0) (1) (1) Investment in associates 14 1 (4) (9) (14) Other non-current assets 32 65 65 65 65 Total non-current assets 553 735 892 1,018 1,115 Accounts & bills payable 471 774 1,129 1,553 1,894 Other payables and accruals 128 164 242 330 401 Interest-bearing bank borrowings 62 103 203 203 203 Other current liabilities 9 11 11 11 11 Total current liabilities 671 1,052 1,585 2,096 2,509 Total non-current liabilities 24 18 18 18 18 Shareholders’ equity 1,661 1,922 2,263 2,693 3,184 Minority interest 20 10 1 (10) (23) Total equity 1,681 1,932 2,264 2,683 3,161


FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Profit before tax 240 397 515 650 761 Depreciation and amortization 92 109 138 168 198 Change in working capital (228) (200) (389) (377) (307) Other (31) (49) (77) (98) (114) Operating cash flow 72 257 187 344 539 Capex (197) (293) (300) (300) (300) Other 284 113 10 10 10 Investment cash flow 87 (180) (290) (290) (290) Change in borrowings (31) 23 100 0 0 Other (66) (109) (110) (139) (174) Financing cash flow (97) (86) (10) (139) (174) Change in cash 63 (8) (113) (85) 74 Exchange losses on cash and cash equivalents

0 0 0 0 0

Cash, beginning 188 252 243 130 45 Cash, ending 252 243 130 45 120

FYE 31 December (%) 2011 2012 2013F 2014F 2015F Profitability Gross margin 20.9 18.6 17.4 16.7 16.5 Operating margin 10.6 10.0 8.8 8.1 7.8 Net margin 8.6 8.7 7.6 7.0 6.8 ROE 12.8 17.9 19.7 21.0 20.9 Growth Sales revenue growth 37.4 59.5 47.4 36.3 21.7 Operating income growth 52.1 51.1 28.9 26.3 17.0 Net profit growth 49.7 60.8 28.9 26.3 17.0 EPS growth 51.0 60.1 28.5 25.9 16.7 Liquidity Net debt/equity (%) Net cash Net cash 3.2 5.9 2.6



35

Initiate with Neutral and target price of HK$8.70

We initiate coverage on Sunny Optical (2382 HK) with a Neutral rating and target price of HK$8.70, based on 12x FY14F P/E or two standard deviations above the forward mid-cycle P/E valuation. In our view, Sunny is in pole position to benefit from the migration of smartphone cameras from 5MP to 8MP/13MP by virtue of its impressive market share and unit growth vis-à-vis Chinese smartphone OEMs. However, following strong year-to-date price performance, we believe the positives have largely been priced in, and we see limited upside at this level.

Sunny Optical – YTD price performance versus Hang Seng Index

Sunny Optical – 5-year forward P/E bands

8,800

9,300

9,800

10,300

10,800

11,300

11,800

12,300

1

2

3

4

5

6

7

8

9

10

11

12


HK$

Sunny Optical (LHS) HSCEI (RHS)

Mean

+1s.d.

-1s.d.

-2s.d.

+2s.d.

2x

4x

6x

8x

10x

12x

14x

16x

Jul-08 Feb-09 Oct-09 May-10 Jan-11 Sep-11 Apr-12 Dec-12 Jul-13 Source: Bloomberg Source: Bloomberg

Benefiting from smartphone camera pixel migration. Sunny optical is one of the leading handset camera module manufacturers in China with over 50% market share of Chinese smartphone OEMs. In light of the camera pixel migration from 5MP to 8MP/13MP and robust unit sales growth of its China customers, we believe the company is advantageously positioned to benefit from surging mid- to high-end smartphone camera demand. We forecast its handset camera-related sales revenue will grow 71.3%/47.1% YoY, respectively, in FY13F/14F.

Robust vehicle lens growth positive to overall profitability. We see good revenue opportunities from automobile cameras due to increasing adoption in vehicle rear and front parking cameras. Although we see less than 5% sales contribution in FY13F/14F, sales growth will top 40% with above-company-average gross profit margin.

Intense price competition from local rivals the biggest overhang. We estimate sales revenue growth will top 47.4%/36.3% YoY, respectively, in FY13F/14F owing to the impressive performance of the handset division. However, blended gross profit margin will decline 120bp/70bp to 17.4%/16.7% in FY13F/14F on the shift in the sales mix towards lower-margin handset camera modules. We consider price competition from local rivals to be the biggest overhang for the company in FY14F.

Risks: (1) Intense price competition from local rivals like O-file, Truly and BYDE, (2) the increasing cost of manufacturing, and (3) slower-than-expected smartphone unit sales growth from key China smartphone OEMs.


36

Company background

Established in 1984, Sunny Optical Technology Group (“Sunny Optical”) is engaged in the business of designing, researching and developing, and the manufacturing and selling of optical and optical-related products and scientific instruments. It was listed on the Hong Kong Stock Exchange in 2007.

The company operates in three segments: optical components, optoelectronic products and optical instruments, accounting for approximately 32.9%, 62.5% and 4.6% of Sunny Optical’s FY12 revenue, respectively. Its products consist of optical components, such as glass spherical and spherical lenses, plane products, prisms, handset lens sets, vehicle lens sets and other lens sets; optoelectronic products, such as handset camera modules, security cameras and other optoelectronic modules, and optical instruments, such as microscopes, optical measuring instruments and various optical analytical instruments.


Mr. Wang Wenjian, the honorary chairman of the board and non-executive director of Sunny Optical, together with Sunny Employee Trust, hold the entire issued share capital of Sun Xu Limited. Sun Xu Limited owns a 42.15% stake in Sunny Optical, while public shareholders collectively own a 57.85% stake.


Source: Company

R&D capabilities

Sunny Optical possesses five production bases in China, located in Xinyang, Zhejiang, Zhongshan, Shanghai and Tianjin. It has also established R&D centers in China, Singapore, and South Korea, among other locales.

In 2012, the new production base in Xinyang, Henan Province completed the construction of certain factories where the production lines of some of its digital camera-related products were transferred. Sunny Optical also conducted R&D upgrades of existing products, enhanced processing techniques, pushed forward “automation-based innovation” and further consolidated technological advantages for its existing products.


37

With regard to the optical components business segment, 8MP handset lens sets commenced mass production this year while 10MP and above handset lens sets were in the processes of active R&D and trial production. Besides the mobile phone-related business, vehicle lens sets, industrial lenses, and infrared lens sets have been the main areas of focus. For the optoelectronic products business segment, the mass production of 8MP and 13MP handset camera modules began in 2011/2012. Sunny Optical has138 patents, with 68 patents pending approval.

Sunny Optical production bases in China

Source: Company


38

Financial summary

We look for net income growth of 28.9%/26.3% YoY for Sunny Optical in FY13F/14F, to reach RMB446.3m/RMB563.8m on handset camera pixel migration within the China smartphone market.


6%

8%

10%

12%

14%

16%

18%

20%

22%

0

2,000

4,000

6,000

8,000

10,000


RMB m


Encouraging sales growth. We look for a revenue growth of 47.4%/36.3% YoY, respectively, in FY13F/14F, owing to impressive performance from the handset division, underpinned by the camera pixel migration from 5MP to 8MP/13MP in the China smartphone market. On the other hand, increasing adoption in rear/front parking cameras is expected to boost the revenue of Sunny Optical’s vehicle lens division in FY13F/14F. In addition, the company expects there to be breakthroughs in security surveillance lens sets and new optical instruments in FY13.

Tumbling gross profit margin. Despite the impressive revenue growth, we expect from Sunny Optical, we see its blended gross profit margin declining 120bp/70bp YoY to 17.4%/16.7% in FY13F/14F due to the shift in the sales mix towards lower-margin handset camera modules and severe price competition from local rivals.

Stable opex/sales ratio. We expect the operating expense-over-sales ratio to hold steady at 9.5%/9.2% in FY13F/14F, similar to the 9.5% achieved in FY12. Focusing on automation will help Sunny Optical maintain a stable opex/sales ratio.

ROE and low gearing ratio. With its leading position in China’s handset camera module market, we expect Sunny Optical to produce favorable ROE of 19.7%/21.0% and maintain a low-single-digit gearing ratio in FY13F/14F.

Capex. A stable level of capex amounting to approximately RMB300m is expected for FY13F/14F, to be put towards the purchase of property, plant, equipment and other tangible assets.


39

Sunny Optical – income statement

FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F 1H12 2H12 1H13 2H13F Revenue 2,499 3,984 5,872 8,004 9,740 1,770 2,215 2,620 3,252 Cost of revenue (1,976) (3,243) (4,850) (6,668) (8,133) (1,430) (1,814) (2,184) (2,666) Gross profit 523 741 1,022 1,337 1,607 340 401 435 586 Gross profit margin 20.9 18.6 17.4 16.7 16.5 19.2 18.1 16.6 18.0 Other income and gains 54 36 50 50 50 24 12 25 25 Selling and distribution expense (59) (64) (95) (120) (146) (32) (33) (45) (50) R&D expense (131) (163) (241) (320) (390) (68) (95) (105) (136) Administrative expense (123) (150) (221) (296) (360) (75) (75) (105) (116) Operating profit 264 399 515 650 761 189 210 206 309 Operating margin 10.6 10.0 8.8 8.1 7.8 10.7 9.5 7.9 9.5 Net interest income 6 7 5 5 5 2 4 3 2 Share of result of associates (4) (4) (5) (5) (5) (3) (2) (3) (3) Other (26) (5) 0 0 0 (1) (3) 0 0 Profit before tax 240 397 515 650 761 188 210 207 308 Tax expense (38) (58) (77) (98) (114) (32) (26) (31) (46) Minority interest 14 7 9 11 13 1 6 4 5 Profit to shareholders 215 346 446 564 660 157 190 179 267 Net profit margin 8.6 8.7 7.6 7.0 6.8 8.8 8.6 6.8 8.2 EPS (RMB) 0.22 0.35 0.45 0.57 0.67 0.16 0.19 0.18 0.27 EPS (HK$) 0.26 0.43 0.57 0.72 0.86 0.20 0.24 0.23 0.34 EPS growth (%) 51.0 60.1 28.5 25.9 16.7 70.9 52.7 13.7 40.3 Gross profit margin (%) 20.9 18.6 17.4 16.7 16.5 19.2 18.1 16.6 18.0 Operating profit margin (%) 10.6 10.0 8.8 8.1 7.8 10.7 9.5 7.9 9.5 Net profit margin (%) 8.6 8.7 7.6 7.0 6.8 8.8 8.6 6.8 8.2 ROE (%) 12.8 17.9 19.7 21.0 20.9 Net debt/equity (%) Net cash Net cash 3.2 5.9 2.6 Source: Historical data from the Company, forecasts by CCBIS

ZTE Corporation (763 HK) 7 August 2013

40

ZTE Corporation (763 HK)

On the right track Company Rating:

Outperform (maintained)

Maintain Outperform with higher target price of HK$20.00. We maintain our Outperform rating on ZTE and keep our earnings forecasts for the company unchanged. We raise our target price from HK$15.00 to HK$20.00 based on a higher target multiple of 20x FY14 P/E, in line with the average 3-year mid-cycle P/E valuation during the previous 3G telecom capex cycle. Better cost controls, higher telecom equipment spending and robust smartphone unit growth should justify our positive outlook for ZTE.

Now a meaningful smartphone player. According to IDC, ZTE was the fifth-largest smartphone manufacturer in the world in 2Q13 with 10.1m units shipped. We forecast the company will ship 40m smartphones in FY13F resulting in gross profit margin of 16.5% for the mobile terminal division. ZTE is shifting focus to higher ASP smartphones and the overseas market.

Rising mobile equipment orders from Chinese telecom operators. Telecom equipment orders from China Mobile fell short of expectations in 1H13. However, TD-LTE tenders from China Mobile should be out in 2H13F, boosting sales and profits for leading China telecom equipment vendors. Besides China Mobile, China Telecom appears set to move up the date of its 4G trials, a positive development for ZTE, in our view.

Looking forward to a better 2014F. ZTE has already announced preliminary 1H13 results, including a 23.5% YoY increase in net income to RMB302.3m. 1H13 was a mixed bag that included a higher forex loss in 1H13. On a more positive note, GPM is improving and operating expenses are coming under control. Increasing 4G capex from leading telecom operators and robust smartphone sales growth will support a profitable 2013F and 26% earnings growth for 2014F, in our view.

Forecasts and valuation Year to 31 December 2011 2012 2013F 2014F 2015F Revenue (RMB m) 86,254 84,219 96,270 106,531 117,615 Net profit (RMB m) 2,060 (2,841) 2,128 2,672 3,372 Revision (%) N/A N/A (22.4) (5.7) 5.3 EPS (RMB) 0.6 (0.8) 0.6 0.8 1.0 YoY change (%) (36.6) N/A N/A 25.6 26.2 DPS (RMB cent) 20.2 0.0 15.5 19.5 24.6 Dividend yield (%) 1.8 0.0 1.4 1.8 2.3 P/E (x) 18.9 (13.5) 17.5 13.6 10.8 P/B (x) 1.8 2.1 1.9 1.7 1.5 ROE (%) 7.8 (12.5) 8.5 9.8 11.2 Source: Company data, CCBIS estimates

Price: HK$13.60 Target: HK$20.00 (up from HK$15.00) Trading data 52-week range HK$9.23 – 15.6 Market capitalization (m) HK$60,870/US$7,964 Shares outstanding (m) 3,440 Free float (%) 69.2 3M average daily T/O (m share) 5.4 3M average daily T/O (US$m) 9.5 Expected return (%) – 1 year 47.0 Closing price on 7 August 2013


8

13

18

23

28

33


HK$

ZTE HSCEI (rebased) Source: Bloomberg





41

ZTE – financial summary


FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Revenue 86,254 84,219 96,270 106,531 117,615 Carrier networks 46,522 41,603 44,714 47,307 50,208 Terminals 26,934 25,839 33,100 38,000 43,000 Telecommunication software systems, services & other products

12,799 16,778 18,456 21,224 24,408

Cost of revenue (62,086) (65,546) (72,158) (80,219) (88,902) Gross profit 24,168 18,674 24,112 26,312 28,713 Other income & gains 3,381 4,359 3,706 4,347 5,127 Sell & distribution costs (11,112) (11,341) (11,745) (12,784) (14,114) G&A expenses (2,606) (2,449) (2,696) (2,876) (3,176) R&D expenses (8,493) (8,829) (8,664) (9,481) (10,350) Other operating expenses (1,684) (706) (963) (1,065) (1,176) Operating profit 3,654 (292) 3,750 4,453 5,024 Net interest income (1,091) (1,739) (1,100) (1,105) (780) Associate income 71 48 75 75 75 Profit before tax 2,635 (1,983) 2,725 3,423 4,319 Tax expense (392) (621) (450) (565) (713) Minority interest (183) (236) (148) (186) (234) Profit to shareholders 2,060 (2,841) 2,128 2,672 3,372 EPS (RMB) 0.61 (0.83) 0.62 0.78 0.98 EPS (HK$) 0.72 (1.01) 0.78 1.00 1.26

FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Cash & bank balances 20,662 22,660 17,770 18,354 13,530 Trade & bills receivable 30,720 30,516 33,595 37,146 40,990 Prepayment & other receivables 5,029 5,227 5,975 6,612 7,300 Inventories 14,988 11,442 17,792 19,780 21,921 Other current assets 15,513 15,259 17,214 18,879 20,678 Current assets 86,912 85,104 92,347 100,771 104,419 PPT 8,646 8,011 8,300 8,422 8,375 Intangible assets 2,240 2,625 2,659 2,543 2,377 Interests in associates 468 409 484 559 634 Investment in JCE 46 47 47 47 47 Other non-current assets 9,472 13,716 14,463 15,100 15,788 Total non-current assets 20,872 24,808 25,954 26,671 27,221 Trade & bill payable 32,692 29,594 37,562 41,758 46,278 Other payables & accruals 13,408 14,834 16,330 18,155 20,120 Short-term borrowings 15,666 22,599 23,016 23,474 23,979 Other current liabilities 4,124 8,398 4,728 11,262 5,612 Total current liabilities 65,891 75,424 81,636 94,649 95,988 Total non-current liabilities 15,605 11,849 11,750 5,553 5,472 Shareholders’ equity 24,232 21,502 23,630 25,771 28,475 Minority interest 2,057 1,136 1,284 1,470 1,704 Total equity 26,289 22,639 24,914 27,241 30,179


FYE 31 December (RMB m) 2011 2012F 2013F 2014F 2015F Profit before tax 2,635 (1,983) 2,725 3,423 4,319 Depreciation & amortization 1,407 1,549 1,777 1,995 2,212 Change in working capital (6,118) 2,793 (2,650) (1,573) (1,712) Other (1,580) (486) (525) (1,172) (1,456) Operating cash flow (3,655) 1,873 1,328 2,673 3,364 Capex (2,548) (1,678) (1,500) (1,500) (1,500) Other (1,062) (2,699) (600) (500) (500) Investment cash flow (3,610) (4,377) (2,100) (2,000) (2,000) Change in borrowings 13,428 603 (99) (89) (80) Other 7 3,899 (4,018) 0 (6,108) Financing cash flow 13,435 4,502 (4,117) (89) (6,188) Change in cash 6,169 1,998 (4,890) 584 (4,824) Effect of foreign ex. rate change (412) 0 0 0 0 Cash, beginning 14,905 20,662 22,660 17,770 18,354 Cash, ending 20,662 22,660 17,770 18,354 13,530

FYE 31 December (%) 2011 2012 2013F 2014F 2015F Profitability Gross margin 28.0 22.2 25.0 24.7 24.4 Operating margin 4.2 (0.3) 3.9 4.2 4.3 Net margin 2.4 (3.4) 2.2 2.5 2.9 ROE 7.8 (12.5) 8.5 9.8 11.2 Growth Sales revenue growth 23.4 (2.4) 14.3 10.7 10.4 Operating income growth (26.1) N/A N/A 18.7 12.8 Net profit growth (36.6) N/A N/A 25.6 26.2 EPS growth (36.6) N/A N/A 25.6 26.2 Liquidity Net debt/equity 34.9 60.1 59.4 53.5 45.5

Source: Company historical data, CCBIS forecasts


42

ZTE – income statement

FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F 1H11 2H11 1H12 2H12 Revenue 86,254 84,219 96,270 106,531 117,615 37,013 49,241 42,642 41,578 Carrier networks 46,522 41,603 44,714 47,307 50,208 Terminals 26,934 25,839 33,100 38,000 43,000 Telecommunication software systems, services and other products

12,799 16,778 18,456 21,224 24,408

Cost of revenue (62,086) (65,546) (72,158) (80,219) (88,902) (26,901) (35,186) (32,141) (33,405) Gross profit 24,168 18,674 24,112 26,312 28,713 10,112 14,056 10,501 8,173 Gross profit margin 28.0 22.2 25.0 24.7 24.4 27.3 28.5 24.6 19.7 Other income and gains 3,381 4,359 3,706 4,347 5,127 2,065 1,316 1,646 2,714 Sell and distribution costs (11,112) (11,341) (11,745) (12,784) (14,114) (4,984) (6,129) (5,402) (5,939) G&A expenses (2,606) (2,449) (2,696) (2,876) (3,176) (1,260) (1,345) (1,153) (1,296) R&D expenses (8,493) (8,829) (8,664) (9,481) (10,350) (3,664) (4,828) (4,025) (4,804) Other operating expenses (1,684) (706) (963) (1,065) (1,176) (547) (1,137) (409) (297) Operating profit 3,654 (292) 3,750 4,453 5,024 1,721 1,933 1,157 (1,449) Operating margin 4.2 (0.3) 3.9 4.2 4.3 4.6 3.9 2.7 (3.5) Net interest income (1,091) (1,739) (1,100) (1,105) (780) (458) (633) (494) (1,246) Associate income 71 48 75 75 75 9 62 (8) 56 Profit before tax 2,635 (1,983) 2,725 3,423 4,319 1,273 1,362 656 (2,639) Tax expense (392) (621) (450) (565) (713) (436) 44 (264) (358) Minority interest (183) (236) (148) (186) (234) (67) (116) (147) (89) Profit to shareholders 2,060 (2,841) 2,128 2,672 3,372 769 1,291 245 (3,086) Net profit margin 2.4 (3.4) 2.2 2.5 2.9 2.1 2.6 0.6 (7.4) EPS (RMB) 0.6 (0.8) 0.6 0.8 1.0 0.2 0.4 0.1 (0.9) EPS (HK$) 0.7 (1.0) 0.8 1.0 1.3 0.3 0.4 0.1 (1.1) EPS growth (%) (36.6) N/A N/A 25.6 26.2 (14.3) (46.2) (68.2) N/A Gross profit margin (%) 28.0 22.2 25.0 24.7 24.4 27.3 28.5 24.6 19.7 Operating profit margin (%) 4.2 (0.3) 3.9 4.2 4.3 4.6 3.9 2.7 (3.5) Net profit margin (%) 2.4 (3.4) 2.2 2.5 2.9 2.1 2.6 0.6 (7.4) ROE (%) 7.8 (12.5) 8.5 9.8 11.2 Net debt/equity (%) 34.9 60.1 59.4 53.5 45.5 Source: Company data, CCBIS estimates

AAC Technologies (2018 HK) 7 August 2013

43

AAC Technologies (2018 HK) 24 July 2013

Still a good bargain Company Rating:

Outperform (upgrade from Neutral)

Upgrade to Outperform with HK$42.80 target price. We like AAC's leadership in acoustic components, its penetration of leading smartphone and tablet OEMs and its strong design-in capabilities. We see weakness ACC exhibited in 2Q13 and concerns over slowing high-end smartphone growth reflected in the recent 25% price correction from its peak. We upgrade our rating on AAC from Neutral to Outperform and raise our target price from HK$36.50 to HK$42.80. We cut our FY14 earnings forecast by 4.7% and roll over to a FY14F P/E valuation. Our new target price is based on 15x FY14F P/E.

2Q13 results underwhelming. AAC Technologies will report 2Q13 results on 16 August. We expect AAC’s sales revenue and net income to grow 40.4% and 34.2% YoY to RMB1.96b and RMB545m, in keeping with the market’s lower expectations for the company. Despite slightly slower-than-expected 2Q13 sales momentum, AAC's penetration of Samsung Electronics (005930 KS, Not Rated) and leading China smartphone customers will underpin solid future performance.

Still comfortable with our 37.3% sales growth forecast for FY13F. We look for sales growth of 37.3% YoY in FY13F driven by higher sales revenue from Samsung and leading China smartphone customers. We expect the wide- scale launch of new products from Apple (AAPL US, Not Rated) in late 3Q13F to benefit AAC in FY13F.

In position to ride tablet adoption. AAC can take advantage of the mass adoption of tablets given its leading position in design-in acoustic solutions. Good traction penetrating leading tablet OEMs along with robust tablet unit growth will support sales growth at AAC in FY14F.

Forecasts and valuation Year to 31 December 2011 2012 2013F 2014F 2015F Revenue (RMB m) 4,060 6,283 8,625 10,307 12,160 Net profit (RMB m) 1,036 1,763 2,394 2,734 3,223 Revision (%) N/A N/A 0.0 (4.7) (4.7) EPS (RMB) 0.84 1.44 1.95 2.23 2.62 YoY change (%) 5.0 70.1 35.8 14.2 17.9 DPS (RMB cents) 33.9 57.5 78.0 89.0 105.0 Dividend yield (%) 1.1 2.0 2.7 3.2 3.8 P/E (x) 35.4 20.3 14.6 12.5 10.6 P/B (x) 7.6 5.8 4.6 3.6 3.0 ROE (%) 21.5 28.8 31.4 29.2 28.3 Source: Company data, CCBIS estimates

Price: HK$35.55 Target: HK$42.80 (up from HK$36.50) Trading data 52-week range HK$20.10 – 47.95 Market capitalization (m) HK$43,712/US$5,626 Shares outstanding (m) 1,228 Free float (%) 56.5 3M average daily T/O (m share) 6.5 3M average daily T/O (US$m) 29.9 Expected return (%) – 1 year 20.4 Price as at close on 24 July 2013


8

12

16

20

24

28

32

36

40

44

48

Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13

HK$

AAC HSCEI (rebased) Source: Bloomberg





44

AAC Technologies – financial summary


FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Revenue 4,060 6,283 8,625 10,307 12,160 Cost of revenue (2,275) (3,509) (4,818) (5,865) (6,919) Gross profit 1,784 2,774 3,807 4,442 5,241 Other income & gains 35 57 45 50 55 Sell & distribution costs (137) (186) (259) (309) (365) G&A expenses (153) (277) (371) (443) (523) R&D expenses (358) (462) (578) (691) (815) Operating profit 1,171 1,905 2,644 3,049 3,594 Net interest income 22 4 5 10 15 Associate Income (19) 26 55 65 75 Foreign exchange difference (33) 45 31 0 0 Disposal gain on associate 0 35 0 0 0 Profit before tax 1,142 2,016 2,735 3,124 3,684 Tax expense (109) (259) (342) (391) (460) Minority interest 3 6 1 0 0 Profit to shareholders 1,036 1,763 2,394 2,734 3,223 EPS (RMB) 0.84 1.44 1.95 2.23 2.62 EPS (HK$) 1.00 1.75 2.44 2.85 3.37

FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Cash and bank balances 1,374 1,314 1,676 2,755 4,144 Trade & bills receivable 1,219 1,908 2,599 3,106 3,665 Prepayments & other receivables 268 421 531 669 843 Inventories 559 958 1,320 1,607 1,896 Other current assets 5 6 6 6 6 Current assets 3,425 4,607 6,133 8,143 10,554 PPT 2,697 3,624 4,071 4,211 4,311 Intangible assets 162 144 128 111 94 Interests in associates 182 242 297 362 437 Other non-current assets 248 308 308 308 308 Total non-current assets 3,289 4,319 4,803 4,991 5,149 Trade and bills payable 636 1,128 1,518 1,848 2,180 Other payables & accruals 262 447 564 710 895 Short-term borrowings 891 1,035 1,035 1,035 1,035 Other current liabilities 97 141 141 141 141 Total current liabilities 1,887 2,751 3,258 3,734 4,251 Total non-current liabilities 16 44 44 44 44 Shareholders’ equity 4,750 6,078 7,584 9,306 11,357 Minority interest 61 52 51 51 51 Total equity 4,811 6,130 7,635 9,357 11,408


FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F Profit before tax 1,142 2,016 2,735 3,124 3,684 Depreciation & amortization 259 343 420 477 517 Change in working capital (403) (646) (657) (455) (504) Other (53) (177) (402) (466) (550) Operating cash flow 945 1,535 2,096 2,680 3,146 Capex (1,040) (1,159) (850) (600) (600) Other (279) (180) 20 25 30 Investment cash flow (1,319) (1,339) (830) (575) (570) Change in borrowings 427 191 0 0 0 Other (406) (443) (903) (1,027) (1,187) Financing cash flow 21 (251) (903) (1,027) (1,187) Change in cash (353) (56) 363 1,078 1,389 Effect of foreign exchange rate changes (8) (5) 0 0 0 Cash, beginning 1,735 1,374 1,314 1,676 2,755 Cash, ending 1,374 1,314 1,676 2,755 4,144

FYE 31 December (%) 2011 2012 2013F 2014F 2015F Profitability Gross margin 44.0 44.2 44.1 43.1 43.1 Operating margin 28.8 30.3 30.7 29.6 29.6 Net margin 25.5 28.1 27.8 26.5 26.5 ROE 21.5 28.8 31.4 29.2 28.3 Growth Sales revenue growth 21.2 54.8 37.3 19.5 18.0 Operating income growth 8.1 62.7 38.8 15.3 17.9 Net profit growth 5.0 70.1 35.8 14.2 17.9 EPS growth 5.0 70.1 35.8 14.2 17.9 Liquidity Net debt/equity Net cash Net cash Net cash Net cash Net cash

Source: Historical data from the company, CCBIS estimates


45

AAC Technologies – earnings revisions

New Previous Change (%) Profit and loss 2013F 2014F 2015F 2013F 2014F 2015F 2013F 2014F 2015F (RMB m) Revenue 8,625 10,307 12,160 8,625 10,515 12,435 0.0 (2.0) (2.2) Gross profit 3,807 4,442 5,241 3,807 4,621 5,458 0.0 (3.9) (4.0) Opex (1,208) (1,443) (1,702) (1,208) (1,462) (1,728) 0.0 (1.3) (1.5) Operating profit 2,644 3,049 3,594 2,644 3,205 3,775 0.0 (4.9) (4.8) Net profit 2,394 2,734 3,223 2,394 2,870 3,382 0.0 (4.7) (4.7) (%) Gross margin 44.1 43.1 43.1 44.1 44.0 43.9 – – – OPEX to sales (14.0) (14.0) (14.0) (14.0) (13.9) (13.9) – – – OPM 30.7 29.6 29.6 30.7 30.5 30.4 – – – Net margin 27.8 26.5 26.5 27.8 27.3 27.2 – – – Source: CCBIS estimates

Greater China handset valuation matrix

CCBIS Share price* Market cap EPS growth (%) P/E (x) Company Stock code rating (HK$) (US$m) CY13F CY14F CY15F CY13F CY14F CY15F Handset brands Lenovo 992 HK Neutral 7.04 9,549 6.9 18.4 N/A 13.9 11.7 N/A ZTE 763 HK Outperform 13.42 8,195 N/A 25.6 26.2 17.2 13.4 10.7 HTC 2498 TT Not Rated 167.5 4,764 -50.8 46.5 7.6 16.9 11.5 10.7 China Wireless 2369 HK Not Rated 2.62 701 40.4 26.9 55.1 12.1 9.6 6.2 TCL 2618 HK Not Rated 3.49 517 N/A 612.8 71.3 N/A 10.4 6.1 Average 15.0 11.3 8.4 Handset components and others MediaTek 2454 TT Not Rated 353.5 15,922 43.9 25.8 5.9 19.0 15.1 14.3 AAC 2018 HK Outperform 35.55 5,769 35.8 14.2 17.9 14.6 12.5 10.6 Largan Precision 3008 TT Not Rated 909 4,070 41.2 16.4 NA 15.5 13.3 NA FIH 2038 HK Not Rated 4.3 4,056 N/A N/A NA N/A N/A NA Unimicron Tech 3037 TT Not Rated 28.9 1,484 8.8 16.1 5.6 11.8 10.2 9.6 Spreadtrum SPRD US Not Rated 29.82 1,454 36.7 12.8 4.9 10.9 9.7 9.2 Truly International 732 HK Not Rated 3.83 1,337 39.5 13.1 33.3 10.7 9.5 7.1 Sunny Optical 2382 HK Not Rated 8.2 1,041 41.2 31.1 31.7 13.2 10.1 7.7 Merry Electronics 2439 TT Not Rated 64.3 378 54.4 12.3 N/A 15.2 13.6 N/A Average 13.9 11.7 9.7 * Price as at close on 24 July 2013 Source: Bloomberg, CCBIS estimates


46

AAC – income statement

FYE 31 December (RMB m) 2011 2012 2013F 2014F 2015F 1Q13 2Q13F 3Q13F 4Q13F Revenue 4,060 6,283 8,625 10,307 12,160 1,905 1,962 2,207 2,552 Dynamic components 3,228 5,052 6,720 7,834 9,181 Microphones 459 774 1,199 1,439 1,655 Headsets 119 70 98 117 141 Other 253 387 608 916 1,183 Cost of revenue (2,275) (3,509) (4,818) (5,865) (6,919) (1,090) (1,101) (1,234) (1,394) Gross profit 1,784 2,774 3,807 4,442 5,241 814 861 973 1,158 Gross profit margin 44.0 44.2 44.1 43.1 43.1 42.7 43.9 44.1 45.4 Other income & gains 35 57 45 50 55 16 10 10 9 Sell and distribution costs (137) (186) (259) (309) (365) (51) (59) (66) (82) G&A expenses (153) (277) (371) (443) (523) (82) (69) (84) (137) R&D expenses (358) (462) (578) (691) (815) (148) (137) (148) (145) Operating profit 1,171 1,905 2,644 3,049 3,594 549 606 685 804 Operating margin 28.8 30.3 30.7 29.6 29.6 28.8 30.9 31.1 31.5 Net interest income 22 4 5 10 15 (3) 3 3 2 Associate income (19) 26 55 65 75 10 10 10 25 Foreign exchange difference (33) 45 31 0 0 31 0 0 0 Disposal gain on associate 0 35 0 0 0 0 0 0 0 PBT 1,142 2,016 2,735 3,124 3,684 587 619 698 830 Tax expense (109) (259) (342) (391) (460) (54) (74) (84) (130) MI 3 6 1 0 0 1 0 0 (0) Profit to shareholders 1,036 1,763 2,394 2,734 3,223 534 545 615 701 Net profit margin 25.5 28.1 27.8 26.5 26.5 28.0 27.8 27.8 27.5 EPS (RMB) 0.84 1.44 1.95 2.23 2.62 0.43 0.44 0.50 0.57 EPS (HK$) 1.00 1.75 2.44 2.85 3.37 0.54 0.55 0.63 0.71 EPS growth (%) 5.0 70.1 35.8 14.2 17.9 69.9 34.2 29.9 23.1 GPM (%) 44.0 44.2 44.1 43.1 43.1 42.7 43.9 44.1 45.4 OPM (%) 28.8 30.3 30.7 29.6 29.6 28.8 30.9 31.1 31.5 NPM (%) 25.5 28.1 27.8 26.5 26.5 28.0 27.8 27.8 27.5 ROE (%) 21.5 28.8 31.4 29.2 28.3 Net debt/equity (%) Net cash Net cash Net cash Net cash Net cash Source: Company data, CCBIS estimates

Lenovo Group (992 HK) 7 August 2013

47

Lenovo Group (992 HK) 2 July 2013

Wait for a better entry point Company Rating:

Neutral (maintained)

Expect a solid 1QFY14. Lenovo will report 1QFY14 results in mid-August. We look for sales revenue of US$8.2b and net income of US$160m, up 2.1% and 12.9% YoY, respectively, and slightly below the Bloomberg consensus estimates. We expect its 1QFY14 OPM will show a 20bp increase from last year to 2.5% on improving smartphone profitability in China and better economies of scale from the PC division.

Weak PC demand still the biggest overhang. Lenovo’s PC division did well in last year. The company has grown rapidly and is now the second-largest PC vendor globally. Despite this success, lackluster PC industry growth in 2013F and 2014F will weigh on the company's overall performance, in our view. For this reason we remain cautious on the stock and expect modest 2.4% PC shipment growth in FY14F.

Encouraging traction in smart devices but not good enough. Lenovo has invested heavily in the Mobile Internet and Digital Home Business Group (MIDH) that develops smart-devices. MIDH smartphone and tablet shipments were up 3.7x or 74% YoY to 29.0m smartphone units and 2.2m tablet units in FY13. We expect the MIDH division to break even in FY14F, with 43.0m smartphone shipments and 8.0m tablet shipments.

Maintain Neutral. We remain cautious on the overall PC market in view of faster-than-expected tablet cannibalization and slower replacement demand. We maintain our Neutral rating and HK$7.60 target price on Lenovo, still based on 15x forward P/E. We keep our FY14F/15F earnings estimates largely unchanged.

Forecasts and valuation Year to 31 March 2012 2013 2014F 2015F 2016F Revenue (US$m) 29,574 33,873 35,839 38,014 39,032 Net profit (US$m) 473 635 684 774 823 Revision (%) – – 0.7 (3.8) N/A EPS (US cent) 4.57 6.07 6.54 7.39 7.87 YoY change (%) 67.5 32.7 7.7 13.1 6.5 DPS (US cent) 1.31 1.82 1.94 2.23 2.33 Dividend yield (%) 1.5 2.0 2.2 2.5 2.6 P/E (x) 19.6 14.8 13.7 12.1 11.4 P/B (x) 3.9 3.5 3.0 2.6 2.3 ROE (%) 19.3 23.7 22.0 21.5 20.0 Source: Company data, CCBIS estimates

Price: HK$7.00 Target: HK$7.60 (maintained) Trading data 52-week range HK$5.35 – 9.07 Market capitalization (m) HK$73,242/US$9,217 Shares outstanding (m) 10,463 Free float (%) 55.3 3M average daily T/O (m share) 56.1 3M average daily T/O (US$m) 50.4 Expected return (%) – 1 year 8.5 Closing price on 2 July 2013


3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Jan-10 Nov-10 Oct-11 Aug-12 Jul-13

HK$

Lenovo HSCEI (rebased) Source: Bloomberg





48

Lenovo Group – financial summary


FYE 31 March (US$m) 2013 2014F 2015F 2016F Revenue 33,873 35,839 38,014 39,032 Cost of revenue (29,800) (31,422) (33,262) (34,153) Gross profit 4,074 4,417 4,752 4,879 Other income & gains 20 0 0 0 Sell & distribution costs (1,888) (1,992) (2,129) (2,186) G&A expenses (847) (897) (950) (976) R&D expenses (624) (675) (646) (625) Other operating income/expenses 65 20 0 0 Operating profit 800 872 1,026 1,093 Net finance cost 2 8 5 5 Associate Income (1) 0 0 0 Profit before tax 801 880 1,031 1,098 Tax expense (170) (197) (258) (274) Minority interest 4 0 0 0 Profit to shareholders 635 684 774 823 EPS (US cent) 6.07 6.54 7.39 7.87 EPS (HK cent) 47.35 50.97 57.66 61.38

FYE 31 March (US$m) 2013 2014F 2015F 2016F Cash & bank balances 3,454 3,979 4,756 5,530 Trade & bill receivables 3,458 3,552 3,767 3,868 Prepayment & other receivables 3,235 3,423 3,631 3,728 Inventory 1,965 2,066 2,278 2,339 Other current assets 277 281 285 286 Current assets 12,390 13,301 14,717 15,752 Property, plant & equipment 480 477 464 442 Intangible assets 3,326 3,206 3,086 2,966 Interests in associates 3 3 3 3 Other non-current assets 683 783 783 783 Total non-current assets 4,492 4,470 4,337 4,194 Trade & bill payable 3,724 3,979 4,212 4,325 Other payables & accruals 7,629 8,044 8,515 8,744 Short-term borrowings 176 176 176 176 Other current liabilities 563 584 608 620 Total current liabilities 12,091 12,783 13,512 13,864 Total non-current liabilities 2,110 1,881 1,937 1,964 Shareholders’ equity 2,667 3,093 3,591 4,105 Minority interest 14 14 14 14 Total equity 2,680 3,106 3,605 4,118


FYE 31 March (US$m) 2013 2014F 2015F 2016F Profit before tax 801 880 1,031 1,098 Depreciation & amortization 287 243 253 263 Change in working capital (823) 379 146 118 Other (246) (248) (308) (324) Operating cash flow 20 1,254 1,122 1,154 Capex (106) (100) (100) (100) Other (139) (69) 30 30 Investment cash flow (245) (169) (70) (70) Change in borrowings 229 (303) 0 0 Other (297) (258) (275) (310) Financing cash flow (68) (561) (275) (310) Change in cash (294) 525 777 774 Effect of foreign exchange rate changes (10) 0 0 0 Cash, beginning 3,758 3,454 3,979 4,756 Cash, ending 3,454 3,979 4,756 5,530

FYE 31 March (%) 2013 2014F 2015F 2016F Profitability Gross margin 12.0 12.3 12.5 12.5 Operating margin 2.4 2.4 2.7 2.8 Net margin 1.9 1.9 2.0 2.1 ROE 23.7 22.0 21.5 20.0 Growth Sales revenue growth 14.5 5.8 6.1 2.7 Operating income growth 37.0 9.1 17.6 6.5 Net profit growth 34.3 7.7 13.1 6.5 EPS growth 32.7 7.7 13.1 6.5 Liquidity Net debt/equity (%) Net cash Net cash Net cash Net cash

Source: Historical data from the company, forecasts by CCBIS


49

Lenovo Group – earnings revisions

New Previous % change US$m 2014F 2015F 2016F 2014F 2015F 2016F 2014F 2015F 2016F Revenue 35,839 38,014 39,032 39,386 44,593 N/A (9.0) (14.8) N/A Gross profit 4,417 4,752 4,879 4,707 5,329 N/A (6.2) (10.8) N/A Opex (3,565) (3,725) (3,786) (3,781) (4,236) N/A (5.7) (12.1) N/A Operating profit 872 1,026 1,093 926 1,093 N/A (5.7) (6.1) N/A Net profit 684 774 823 679 804 N/A 0.7 (3.8) N/A (%) Gross margin 12.3 12.5 12.5 12.0 12.0 N/A OPEX to sales (9.9) (9.8) (9.7) (9.6) (9.5) N/A Operating profit margin 2.4 2.7 2.8 2.4 2.5 N/A Net margin 1.9 2.0 2.1 1.7 1.8 N/A Source: Bloomberg, CCBIS estimate

Lenovo’s record WW market share in 4QFY13: c.15.3% Lenovo’s sales mix by product

7.5%

8.5%

9.5%

10.5%

11.5%

12.5%

13.5%

14.5%

15.5%

16.5%

1QFY

10

2QFY

10

3QFY

10

4QFY

10

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

0

1,500

3,000

4,500

6,000

7,500

9,000

10,500

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

1QFY

14F

2QFY

14F

3QFY

14F

4QFY

14F

US$m

0%5%10%15%20%25%30%35%40%45%50%55%

Desktop Notebook Other MIDH Lenovo sales YoY Source: IDC Source: Company, CCBIS estimates

Lenovo’s latest smartphone – K900 Lenovo’s latest notebook – X1 Carbon

Source: Company Source: Company


50

Technology company valuation matrix

CCBIS Share price* Market cap EPS growth (%) P/E (x) Company Stock code rating (local currency) (US$m) CY13F CY14F CY15F CY13F CY14F CY15F PC brands Apple AAPL US Not Rated 418.49 392,815 (11.4) 10.7 9.9 10.6 9.6 8.7 Hewlett-Packard HPQ US Not Rated 25.02 48,252 N/A 3.0 (2.5) 7.0 6.8 7.0 Dell DELL US Not Rated 13.38 23,496 (25.9) 15.5 (8.5) 13.3 11.5 12.6 Lenovo Group 992 HK Neutral 7.00 9,217 7.7 13.1 6.5 13.7 12.1 11.4 Asustek Computer 2357 TT Not Rated 255.00 6,383 (0.4) (1.1) 3.6 8.6 8.7 8.4 Acer Inc 2353 TT Not Rated 22.60 2,130 NA 53.1 18.6 32.6 21.3 18.0 Average 14.3 11.7 11.0 Notebook & related Hon Hai Precision Industry 2317 TT Not Rated 73.20 28,811 (2.2) 12.0 4.3 9.3 8.3 8.0 Quanta Computer 2382 TT Not Rated 63.50 8,127 (8.8) 10.4 7.4 11.6 10.5 9.8 Compal Electronics 2324 TT Not Rated 19.20 2,817 15.5 13.1 11.0 11.3 10.0 9.0 Pegatron 4938 TT Not Rated 52.00 3,960 67.5 23.3 14.9 11.5 9.3 8.1 Wistron 3231 TT Not Rated 28.00 2,047 6.2 8.9 15.1 8.6 7.9 6.9 Average 10.5 9.2 8.3 Handset & related HTC 2498 TT Not Rated 207.50 5,879 (31.5) 44.6 11.8 15.0 10.4 9.3 ZTE 763 HK Outperform 12.58 7,200 N/A 3.4 13.0 12.5 11.9 10.5 AAC Technologies 2018 HK Neutral 43.75 6,756 35.8 19.9 17.8 18.0 14.6 12.4 Largan Precision 3008 TT Not Rated 953.00 4,251 38.9 15.8 7.4 16.5 14.2 13.3 Foxconn International 2038 HK Not Rated 4.18 3,959 N/A 320.0 (66.7) N/A 25.6 N/A Unimicron Technology 3037 TT Not Rated 29.00 1,484 12.3 19.2 7.7 11.5 9.6 8.9 China Wireless Tech 2369 HK Not Rated 2.90 739 42.9 27.3 52.9 13.2 10.4 6.8 TCL Communication Tech 2618 HK Not Rated 3.65 540 N/A 605.0 73.0 N/A 12.9 7.5 Average 14.4 13.7 9.8 * Closing price as of 2 July 2013 Source: Bloomberg, CCBIS estimates

Risks: (1) Slower-than-expected PC sales in China; (2) intense price competition in developed and developing countries; and (3) larger-than-expected investment in the MIDH division.


51

Lenovo Group – income statement

FYE 31 March (US$m) 2012 2013 2014F 2015F 2016F 1Q14F 2Q14F 3Q14F 4Q14F Revenue 29,574 33,873 35,839 38,014 39,032 8,181 9,103 10,053 8,502 Cost of revenue (26,128) (29,800) (31,422) (33,262) (34,153) (7,175) (8,002) (8,806) (7,439) Gross profit 3,446 4,074 4,417 4,752 4,879 1,006 1,101 1,247 1,063 Gross profit margin 11.7 12.0 12.3 12.5 12.5 12.3 12.1 12.4 12.5 Other income & gains 1 20 0 0 0 0 0 0 0 Sell & distribution costs (1,691) (1,888) (1,992) (2,129) (2,186) (455) (510) (568) (459) G&A expenses (730) (847) (897) (950) (976) (198) (208) (244) (247) R&D expenses (453) (624) (675) (646) (625) (155) (160) (181) (179) Other operating income/expenses 11 65 20 0 0 5 5 5 5 Operating profit 584 800 872 1,026 1,093 203 228 259 183 Operating margin 2.0 2.4 2.4 2.7 2.8 2.5 2.5 2.6 2.2 Net finance cost (1) 2 8 5 5 2 2 2 2 Associate income (1) (1) 0 0 0 0 0 0 0 Profit before tax 582 801 880 1,031 1,098 205 230 261 185 Tax expense (107) (170) (197) (258) (274) (45) (51) (55) (46) Minority interest (2) 4 0 0 0 0 0 0 0 Profit to shareholders 473 635 684 774 823 160 179 206 139 Net profit margin 1.6 1.9 1.9 2.0 2.1 2.0 2.0 2.0 1.6 EPS (US cents) 4.6 6.1 6.5 7.4 7.9 1.52 1.71 1.97 1.33 EPS (HK cents) 35.7 47.3 51.0 57.7 61.4 11.89 13.37 15.35 10.36 EPS growth (%) 67.5 32.7 7.7 13.1 6.5 14.7 10.5 0.6 9.5 Gross profit margin (%) 11.7 12.0 12.3 12.5 12.5 12.3 12.1 12.4 12.5 Operating profit margin (%) 2.0 2.4 2.4 2.7 2.8 2.5 2.5 2.6 2.2 Net profit margin (%) 1.6 1.9 1.9 2.0 2.1 2.0 2.0 2.0 1.6 ROE (%) 19.3 23.7 22.0 21.5 20.0 – – – – Net debt/equity (%) Net cash Net cash Net cash Net cash Net cash – – – – Source: Historical data from the company, forecasts by CCBIS


Rating definitions Outperform (O) – expected return > 10% over the next twelve months

Neutral (N) – expected return between -10% and 10% over the next twelve months

Underperform (U) – expected return < -10% over the next twelve months

Analyst certification: The authors of this report, hereby declare that: (i) all of the views expressed in this report accurately reflect their personal views about any and all of the subject securities or issuers; and (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report; and (iii) they receive no insider information/non-public price-sensitive information in relation to the subject securities or issuers which may influence the recommendations made by them. The authors of this report further confirm that (i) neither they nor their respective associate(s) (as defined in the Code of Conduct issued by the Hong Kong Securities and Futures Commission) has dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of the report; (ii) neither they nor their respective associate(s) serves as an officer of any of the Hong Kong listed companies covered in this report; and (iii) neither they nor their respective associate(s) has any financial interests in the securities covered in this report.

Disclaimers: This report is prepared by CCB International Securities Limited. CCB International Securities Limited is a wholly owned subsidiary of CCB International (Holdings) Limited (“CCBIH”) and China Construction Bank Corporation (“CCB”). Information herein has been obtained from sources believed to be reliable but CCB International Securities Limited, its affiliates and/or subsidiaries (collectively “CCBIS”) do not warrant its completeness or accuracy or appropriateness for any purpose or any person whatsoever. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Investment involves risk and past performance is not indicative of future results. Information in this report is not intended to constitute or be construed as legal, financial, business, tax or any professional advice for any prospective investors and should not be relied upon in that regard. This report is for informational purposes only and should not be treated as an offer or solicitation for the purchase or sale of any products, investments, securities, trading strategies or financial instruments of any kind. Neither CCBIS nor any other persons accept any liability whatsoever for any loss arising from any use of this report or its contents or otherwise arising in connection therewith. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. The opinions and recommendations herein do not take into account prospective investors circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to any prospective investors. The recipients of this report shall be solely responsible for making their own independent investigation of the business, financial condition and prospects of companies referred to in this report. Readers are cautioned that actual results may differ materially from those set forth in any forward-looking statements herein. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the forward-looking statements, opinions and expectations contained herein are based on fair and reasonable assumptions, CCBIS has not been able to verify independently such facts or assumptions and CCBIS shall not be liable for the accuracy, completeness or correctness thereof and no representation or warranty is made, express or implied, in this regard. The recipients must make their own assessments of the relevance, accuracy and adequacy of the information contained in this report and make such independent investigation as they may consider necessary or appropriate for such purpose. Recipients should seek independent legal, financial, business and/or tax advice if they have any doubt about the contents of this report and satisfy themselves prior to making any investment decision that such investment is in line with their own investment objectives and horizons.

The recipients should be aware that CCBIS may do business with the issuer(s) of the securities covered in this report or may hold interest in such securities for itself and/or on behalf of its clients from time to time. As a result, investors should be aware that CCBIS may have a conflict of interest that could affect the objectivity of this report and CCBIS will not assume any responsibility in respect thereof. Where applicable and required, any relationship CCBIS may have with the issuers(s) of the securities or interests in such stocks(s) will be disclosed in this section of the report. The information contained herein may differ or be contrary to opinions expressed by other associates of CCBIS or other members of the CCBIH group of companies.

CCBI has investment banking relationship with ZTE Corporation (763 HK) within the past 12 months.

This report is for distribution only under such circumstances as may be permitted by applicable law. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. This report is not directed at you if CCBIS is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that CCBIS is permitted to provide research material concerning investments to you under relevant legislation and regulations. In particular, this report is only distributed to certain US Persons to whom CCBIS is permitted to distribute according to US securities laws, but cannot otherwise be distributed or transmitted, whether directly or indirectly, into the US or to any US person. This report also cannot be distributed or transmitted, whether directly or indirectly, into Japan and Canada and not to the general public in the People’s Republic of China (for the purpose of this report, excluding Hong Kong, Macau and Taiwan).

Any unauthorized redistribution by any means to any persons, in whole or in part of this research report is strictly prohibited and CCBIS accepts no liability whatsoever for the actions of third parties in distributing this research report.

Copyright 2013 CCBIS. The signs, logos and insignia used in this research report and company name “CCB International Securities Limited” are the trademarks of CCB and/or CCBIS. All rights are hereby reserved.

CCB International Securities Limited 34/F, Two Pacific Place, 88 Queensway, Admiralty, Hong Kong Tel: (852) 2532 6100 / Fax: (852) 2537 0097

Documents

Xtep International (1368 HK)pg.jrj.com.cn/acc/Res/CN_RES/INVEST/2013/8/7/4a62148b-bfc4-442a-… · China-listed smartphone space, we prefer ZTE (763 HK) and TCL Communication (2618