January 10, 2017 Telecommunications China THIS REPORT HAS BEEN PREPARED BY KIM ENG SECURITIES (HK) LTD SEE PAGE 12 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS Company Ticker Rating Current Price (HKD) Target Price (HKD) Tencent 700 HK Not Rated 195.80 NA China Unicom 762 HK BUY 9.27 11.90 China Telecom 728 HK BUY 3.70 5.06 China Mobile 941 HK BUY 84.00 117.00 Mitchell Kim [email protected](852) 2268 0634 Jeffrey Kwong [email protected](852) 2268 0635 China Unicom (762 HK) No Pain, No Gain FY16 was dismal, but Unicom is loaded to go in 2017 We reiterate our BUY on the stock. We hosted China Unicom’s NDR in Malaysia last week where the company held meetings with 20+ investors. The key focus of the discussions was on the potential for a turnaround in the operations of the company in 2017. While the market may become disappointed if the company posts losses in 4Q16, as we now forecast, we believe investors that look ahead to an operational turnaround in 2017 will be rewarded, rather than those who look backward at the dismal 2016. We have lowered our 2016 net profit estimate by 80% and slightly raised 2017/18, but our target price is unchanged as we are more positive on the long-term outlook. Handset and network disadvantages addressed Unicom looks to be more competitive now as 70-80% of new handsets sold in the market in 4Q16 were 6 modes; this allows non-Unicom subscribers to consider Unicom as a second SIM option (Subscriber Identity Module). Further, Unicom’s network coverage is at par or better than its competitors in the 139 key cities in China upon completing the upgrade in October, according to management. Stronger distribution with Internet cooperation Cooperation with Internet partners helps Unicom to: 1) lower commission costs as the company relies less on the traditional 3rd party dealers; 2) promote data SIMs that includes unlimited data access to specific mobile applications, such as unlimited data for all Tencent apps for RMB19/mo; and 3) provide stronger rationale for “mixed ownership” potential. BUY now for the best turnaround story in 2017 With the bulk of the 4G network upgrade now done, management believes Unicom will be much more competitive in 2017. Profitability should improve as 4G ARPU makes greater contributions to growth, and network and marketing cost acceleration slows. Share Price HKD 9.27 12m Price Target HKD 11.90 (+28%) Previous Price Target HKD 11.90 BUY Company Description Statistics 52w high/low (HKD) 3m avg turnover (USDm) Free float (%) Issued shares (m) Market capitalisation Major shareholders: 40.6% 33.8% 2.5% 23,947 63.1 China Unicom engages in the provision of cellular and fixed-line voice, broadband and other information communications technology services. China United Network Communications Ltd. China State-Owned Assets Supervision & A Telefonica SA 10.24/7.77 23.2 HKD222.0B USD28.6B Price Performance 75 80 85 90 95 100 105 110 115 120 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 China Unicom - (LHS, HKD) China Unicom / Hang Seng Index - (RHS, %) -1M -3M -12M Absolute (%) (4) (1) 5 Relative to index (%) (4) 4 (5) Source: FactSet FYE Dec (CNY m) FY14A FY15A FY16E FY17E FY18E Revenue 284,681 277,049 276,982 290,148 299,384 EBITDA 92,771 87,502 80,096 88,615 95,671 Core net profit 12,055 10,562 629 8,536 13,406 Core EPS (CNY) 0.51 0.44 0.03 0.36 0.56 Core EPS growth (%) 14.9 (12.7) (94.0) 1,256.7 57.0 Net DPS (CNY) 0.20 0.17 0.01 0.14 0.22 Core P/E (x) 16.4 18.8 315.5 23.3 14.8 P/BV (x) 0.9 0.9 0.9 0.8 0.8 Net dividend yield (%) 2.4 2.1 0.1 1.7 2.6 ROAE (%) 5.4 4.6 0.3 3.7 5.6 ROAA (%) 2.2 1.8 0.1 1.4 2.1 EV/EBITDA (x) 3.3 3.6 4.2 3.7 3.3 Net gearing (%) (incl perps) 48.9 54.1 60.2 55.4 47.7 Consensus net profit - - 2,142 6,923 10,715 MKE vs. Consensus (%) - - (70.6) 23.3 25.1
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China Unicom (762 HK) BUY · 2017-01-10 · China Unicom 762 HK BUY 9.27 11.90 China Telecom 728 HK BUY 3.70 5.06 China Mobile 941 HK BUYP/BV (x) 84.00 117.00 Net dividend yield (%)
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January 10, 2017
Tele
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THIS REPORT HAS BEEN PREPARED BY KIM ENG SECURITIES (HK) LTD SEE PAGE 12 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS
FY16 was dismal, but Unicom is loaded to go in 2017 We reiterate our BUY on the stock. We hosted China Unicom’s NDR in Malaysia last week where the company held meetings with 20+ investors. The key focus of the discussions was on the potential for a turnaround in the operations of the company in 2017. While the market may become disappointed if the company posts losses in 4Q16, as we now forecast, we believe investors that look ahead to an operational turnaround in 2017 will be rewarded, rather than those who look backward at the dismal 2016. We have lowered our 2016 net profit estimate by 80% and slightly raised 2017/18, but our target price is unchanged as we are more positive on the long-term outlook.
Handset and network disadvantages addressed Unicom looks to be more competitive now as 70-80% of new handsets sold in the market in 4Q16 were 6 modes; this allows non-Unicom subscribers to consider Unicom as a second SIM option (Subscriber Identity Module). Further, Unicom’s network coverage is at par or better than its competitors in the 139 key cities in China upon completing the upgrade in October, according to management.
Stronger distribution with Internet cooperation Cooperation with Internet partners helps Unicom to: 1) lower commission costs as the company relies less on the traditional 3rd party dealers; 2) promote data SIMs that includes unlimited data access to specific mobile applications, such as unlimited data for all Tencent apps for RMB19/mo; and 3) provide stronger rationale for “mixed ownership” potential.
BUY now for the best turnaround story in 2017 With the bulk of the 4G network upgrade now done, management believes Unicom will be much more competitive in 2017. Profitability should improve as 4G ARPU makes greater contributions to growth, and network and marketing cost acceleration slows.
In general, we are positive on the Chinese telcos because we believe the China telecom market growth is attractive considering the upside from the current low data usage per subscriber level. Out of the three Chinese telco stocks we cover, all of which we rate BUY, we prefer Unicom as we roll over to 2017. We remain fascinated by Unicom’s potential turnaround story because we believe it would be a major catalyst for the stock. While 2016 results will likely prove Unicom was the weakest operational performer among the three telco operators, we believe the risk / reward favors Unicom over China Mobile (941 HK, BUY) and China Telecom (728 HK, BUY). The main reason supporting our view is our forecast that Unicom’s operational and profit rebound will likely be much more pronounced than its competitors’. Following the recent Unicom NDR (non-deal roadshow) we hosted, we maintain our view that the operational turnaround is underway and the company will show measurable improvements in 2017, even though we are now factoring in a greater net profit decline for 2016E. However, we recommend investors remain calm despite our anticipation of a possible net loss in 4Q16, as we believe the accelerated network upgrade spending in 2016 will pave the way for a significantly better year in 2017. We recommend investors BUY the stock for 28% upside to our TP. The current stock price performance reminds us of the days when Unicom shares underperformed the HSI in the early 3G launch years of 2009 to 2010 before the share price gained more than 50% in 2011 following the operational turnaround and growing 3G demand. We believe we are at a similar stage now where the shares are languishing because net profit is under pressure, primarily due to the network upgrade cost (and some organizational restructuring general administration costs). Because we believe an operational turnaround is imminent, we remain a buyer of the stock. While the magnitude of the net profit decline in 2016 is more than we anticipated earlier in 2016, we remain patient as we believe the market will focus on the improvements in 2017 instead of focusing on the profit deterioration in 2016. We estimate Unicom’s revenue and net profit growth for 2017 will be 6% and 167%, respectively, on the back of 4G ARPU contribution and network upgrade cost deceleration.
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China Unicom
Fig 1: China Unicom Historical Share Price
Source: Bloomberg
1.1 More competitive with Internet company cooperation Management understands the challenges of competing for data subscribers without a full 4G network. For this reason, Chairman Wang sacrificed margins in 2016 to ensure that Unicom’s 4G offering was at par or even better than its competitors in certain areas. However, the company is trying to leverage its new relationship with Internet platforms to seek incremental revenues from those mobile subscribers who are not Unicom’s subscribers. Unicom is exploring an incremental 2nd SIM slot in mobile phones as 70-80% of the new phones in the market now have 2 SIM slots. The second SIM is easier to penetrate as consumers can try Unicom’s enhanced network without having to cancel their primary subscription. Unicom has been selling low cost or even unlimited data on selected mobile applications recently, which is ideal as a 2nd SIM. For example:
• Tencent “King Card” (腾讯大王卡): RMB19/mo for unlimited data on
all Tencent (700 HK, Not-rated) affiliated websites, applications and products. RMB1/day for 500MB on any other non-Tencent connections.
• Alibaba “Ant Bao Card” (蚂蚁宝卡): RMB36/mo for 2GB data and
100min voice. RMB10/GB after first 2GB, one of the cheapest in the market right now. Subscribers can earn 10MB data for every purchase made through Alipay, with a maximum of 100MB free.
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Fig 2: Tencent “King Card” advertisement
Source: ithome.com
Fig 3: Alibaba “Ant Bao Card” advertisement
Source: ithome.com
We believe there are several benefits from this approach:
1. Leveraging the user base of Internet companies Unicom can leverage the large existing user base of popular mobile apps of these internet companies through their cooperation. For example, WeChat has 800m MAU, while Alipay has 450m annual active users. Since these users will be communicating with WeChat or paying through Alipay regardless of the telecom operator they use, we believe it is likely that subscribers will switch their 2nd SIMs to Unicom at some point during the month attracted by the low cost data.
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China Unicom
2. Unicom can bypass third party distribution channels Traditional third party sellers are unreliable as they often promote the telecom operator that provides them the highest commission. This creates a highly competitive and costly commission based environment. Given the limited resources Unicom has, it is not the optimal choice for distribution. Cooperation with internet companies is commission free, and even more convenient and effective. For example, WeChat users can simply apply for Tencent’s “King Card” within the app, and Unicom will handle the logistics accordingly.
1.2 Turnaround not visible until 2017, but it is on its way Unicom management were optimistic about the potential turnaround in 2017, but had to accelerate network upgrades and general administration restructuring to raise the company’s competitiveness during 2016. We interpreted this as meaning higher spending in 4Q16 than we originally forecast. Accordingly, we have reflected the likelihood of higher expenses in 4Q16, leading to substantially lower net profit estimate for the full year 2016 and a net loss in 4Q16 (note that Unicom would have posted losses in 4Q15 as well if it wasn’t for gains booked for the tower transfer). Management believes Unicom is now in position to overcome challenges related to 4G network coverage and proliferation of six mode 4G handsets. The challenges in 2016 were as follows:
• Difficult to promote 6 modes mobile phones: It took longer than expected for the market to adopt 6 modes phones, because China Mobile actively promoted 3 mode and 5 mode TD LTE only handsets to prohibit or limit its customers from switching to Unicom and Telecom’s FDD-LTE network. 6 modes phone are important to Unicom’s turnaround plan also because the majority of them have 2 SIM slots. We note that 70-80% of the handsets sold in the market in 4Q16 were 6 mode handsets.
• Network upgrade delay: Network upgrades were not fully completed until October. Unicom’s network is now on par or even better than China Mobile’s in the 139 key cities, according to the company. This is part of Unicom’s focus strategy to prioritize most of its resources to these cities only. For other regions, Unicom plans to reduce investments and costs though cooperation with China Telecom.
1.3 Mixed ownership potential Because Unicom’s mixed ownership status is not well understood by the market, many investors asked how mixed ownership would affect the operations of Unicom. Management refrained from providing much detail as the company is still in talks with government. We believe that the potential benefits of mixed ownership could be flexibility to use share based compensation, modelling after Internet companies, to address the weaker competitiveness of Unicom to attract talent in the telecom management area, including marketing and engineering. This could be a catalyst depending on the outcome, although we believe this is not priced-in because it is difficult to conceptualize the benefits.
January 10, 2017 6
China Unicom
Fig 4: Relatively low data usage per sub suggest potential demand upside
Source: Company data, Maybank Kim Eng
Note: China’s 900MB per month per sub is based on 4G handset users.
Fig 5: China Unicom’s share price from 2009 to 2010
Source: Factset
Fig 6: China Unicom’s price performance against HSI from 2009 to 2010
Source: Factset, Maybank Kim Eng
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2. 4Q and year ahead outlook
Management is confident that 2017 will be the turnaround year for the company and expects to see quantifiable results as all upgrades are now completed.
• Management expects revenue to meet the industry average in 2017. This is in line with our estimates.
• A large amount of 4G upgrades were previously coming from 3G subscribers and management said it will be spending more on upgrading 2G subscribers to ease the burden on its 2G network.
• We believe network expenses will remain high for 4G in 4Q16, as Unicom was finalizing its upgrades to be ready for the 2017 roll out. For the year ahead, while Unicom’s lease fees should gradually rise as it expands its network, management expects to see cost savings through a higher co-tenancy ratio in its tower company and through the cooperation with China Telecom.
• While Unicom will be advertising its now comparable 4G services
to the market, management believes that there will be lower commission expenses as they switch to online channels.
3. Estimate changes
Our target price of HKD11.9 is based on a SOTP analysis using DCF for the core operation and the proportional tower value. We are using a WACC of 8.3%, a cost of equity of 10.7%, and a terminal growth of 1%. We significantly lowered our 2016 net profit estimate, but slightly raised 2017 and 2018 (Fig. 7). For 2016, we reflect higher expenses related to network upgrades, marketing and G&A. For 2017 and 2018, we factored in cost savings mentioned above and lower marketing costs resulting from the cooperation with Internet companies.
Fig 7: Estimate changes
Old Forecast New Forecast % Change (CNY m) 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E Operating revenue 275,547 289,830 299,053 276,982 290,148 299,384 1% 0% 0% Service Revenue 241,508 254,775 264,132 242,943 255,094 264,462 1% 0% 0% Sale of telecom products 34,039 35,054 34,921 34,039 35,054 34,921 0% 0% 0%
Best tower-asset play given its smaller market cap. Towers could be worth 30% of Unicom’s market cap when monetized at the IPO, possibly in 2017.
Has been losing higher value subscribers back to CM due to the lack of 4G service coverage. Company more aggressively rolled out its 4G service in 2016.
CU is currently generating insufficient returns due to heavy capex. CU’s RoIC will bottom out in 2016 and track upwards in 2017 as capex declines.
Typically generates FCF in the low to mid-single digits. Its gearing ratio is high, but proceeds from the sale of towers in 2017 could help the company deleverage.
Mobile subscriber data
Source: Company data, Maybank Kim Eng Note: 4G Penetration means the ratio of 4G to total subscribers
Price Drivers
Historical share price trend
Source: Company data, Maybank Kim Eng
1. Took market share from other players with its strong
positioning in 3G. 2. Other players rolled out 3G services successfully and
stabilised. 3. Concerns over profitability with the implementation of
VAT. Also, its competitor, China Mobile (CM), rolled out 4G, which made CU’s 3G services less competitive.
4. Unicom received a 4G licence one year after CM drove up expectations for a level playing field.
5. General market concerns over China’s slowdown and as benefits of tower spin-off remained unclear.
Financial Metrics
Operating margins could be under pressure near-term from rising costs of leasing towers. However, quicker 4G expansion could improve RoIC in the long-term.
Subscriber growth should be back on track after the subscriber write-off in February. We estimate ARPU to rise as the subscriber mix favors 4G.
Capex savings in the next three years should result from base-station sharing arrangements with China Telecom and tower-leasing from TowerCo. FCF expected to improve.
Company pays slightly below a 2% dividend yield starting in FY17E and higher in FY18E.
FCF yield and RoIC
Source: Company data, Maybank Kim Eng
Swing Factors
Upside
Higher than expected value in TowerCo. Better than expected broadband subscriber growth. Cooperation with China Telecom, leading to cost savings
and improving earnings.
Downside
Margins could be squeezed by higher than expected tower-leasing fees.
Further push for rollover of subscribers’ underused data by the Chinese government could impinge on earnings growth.
CNY devaluation could jack up interest payments on foreign currency debt.
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January 10, 2017 14
China Unicom
Historical recommendations and target price: China Unicom (762 HK)
Definition of Ratings
Maybank Kim Eng Research uses the following rating system BUY Return is expected to be above 10% in the next 12 months (excluding dividends) HOLD Return is expected to be between - 10% to +10% in the next 12 months (excluding dividends) SELL Return is expected to be below -10% in the next 12 months (excluding dividends)
Applicability of Ratings
The respective analyst maintains a coverage universe of stocks, the list of which may be adjusted according to needs. Investment ratings are only applicable to the stocks which form part of the coverage universe. Reports on companies which are not part of the coverage do not carry investment ratings as we do not actively follow developments in these companies.
7.0
8.0
9.0
10.0
11.0
12.0
Jun-15 Sep-15 Dec-15 Apr-16 Jul-16 Oct-16 Jan-17
China Unicom
10 Jul Sell : HK$11.7
24 Aug Hold : HK$11.7
23 Oct Buy : HK$13.0
11 Mar Buy : HK$12.7
18 Aug Buy : HK$12.0
24 Oct Buy : HK$11.9
January 10, 2017 15
China Unicom
Malaysia Maybank Investment Bank Berhad (A Participating Organisation of Bursa Malaysia Securities Berhad) 33rd Floor, Menara Maybank, 100 Jalan Tun Perak, 50050 Kuala Lumpur Tel: (603) 2059 1888; Fax: (603) 2078 4194
Singapore Maybank Kim Eng Securities Pte Ltd Maybank Kim Eng Research Pte Ltd 50 North Canal Road Singapore 059304 Tel: (65) 6336 9090
London Maybank Kim Eng Securities (London) Ltd PNB House 77 Queen Victoria Street London EC4V 4AY, UK Tel: (44) 20 7332 0221 Fax: (44) 20 7332 0302
New York Maybank Kim Eng Securities USA Inc 777 Third Avenue, 21st Floor New York, NY 10017, U.S.A. Tel: (212) 688 8886 Fax: (212) 688 3500
Stockbroking Business: Level 8, Tower C, Dataran Maybank, No.1, Jalan Maarof 59000 Kuala Lumpur Tel: (603) 2297 8888 Fax: (603) 2282 5136
Hong Kong Kim Eng Securities (HK) Ltd Level 30, Three Pacific Place, 1 Queen’s Road East, Hong Kong Tel: (852) 2268 0800 Fax: (852) 2877 0104
Indonesia PT Maybank Kim Eng Securities Sentral Senayan III, 22nd Floor Jl. Asia Afrika No. 8 Gelora Bung Karno, Senayan Jakarta 10270, Indonesia Tel: (62) 21 8066 8500 Fax: (62) 21 8066 8501
India Kim Eng Securities India Pvt Ltd 2nd Floor, The International, 16, Maharishi Karve Road, Churchgate Station, Mumbai City - 400 020, India Tel: (91) 22 6623 2600 Fax: (91) 22 6623 2604
Philippines Maybank ATR Kim Eng Securities Inc. 17/F, Tower One & Exchange Plaza Ayala Triangle, Ayala Avenue Makati City, Philippines 1200 Tel: (63) 2 849 8888 Fax: (63) 2 848 5738
Thailand Maybank Kim Eng Securities (Thailand) Public Company Limited 999/9 The Offices at Central World, 20th - 21st Floor, Rama 1 Road Pathumwan, Bangkok 10330, Thailand Tel: (66) 2 658 6817 (sales) Tel: (66) 2 658 6801 (research)
Vietnam Maybank Kim Eng Securities Limited 4A-15+16 Floor Vincom Center Dong Khoi, 72 Le Thanh Ton St. District 1 Ho Chi Minh City, Vietnam Tel : (84) 844 555 888 Fax : (84) 8 38 271 030
Saudi Arabia In association with Anfaal Capital Villa 47, Tujjar Jeddah Prince Mohammed bin Abdulaziz Street P.O. Box 126575 Jeddah 21352 Tel: (966) 2 6068686 Fax: (966) 26068787
South Asia Sales Trading Kevin Foy Regional Head Sales Trading [email protected] Tel: (65) 6636-3620 US Toll Free: 1-866-406-7447
North Asia Sales Trading Andrew Lee [email protected] Tel: (852) 2268 0283 US Toll Free: 1 877 837 7635