6 July 2016 

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Upgrade PCCW to Buy: spotlight on media growth Hong Kong

 Deep dive into Media business: like the prospects of OTT and Neale Anderson* free-to-air; confident Now TV can withstand new competition Head of Telecoms Research, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited [email protected]  Cut HKT forecasts on higher tax, cut DCF valuation, downgrade +852 2996 6716 to Hold: like option on media growth at PCCW Aric Hui* Analyst The Hongkong and Shanghai Banking Corporation Limited  Raise PCCW’s TP by 21% and upgrade to Buy (from Hold) on [email protected] +852 2822 3165 revised valuation of the Media business

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is We like the market position and growth prospects of PCCW Media. We have not registered/ qualified pursuant to FINRA regulations done a deep dive into the Viu Over The Top (OTT) business and believe its focus on Asian (particularly Korean) media means it is clearly differentiated from its peers (iflix, Hooq, and Netflix). It had attracted more than 9m users, in more than 10 markets, by March 2016, and we expect rapid revenue growth to become a key share price driver for PCCW (TP: HKD6.30). The ViuTV Free To Air (FTA) channel was launched in April and has been well received by both audiences and advertisers. Earlier in 2016, we were worried that the Now TV business was at risk from the growth of OTT content in Hong Kong. However, it has moved swiftly to shore up its position with new content, and we expect it can successfully defend its existing subscriber base. We expect PCCW to benefit from economies of scale and scope as it pools staff and resources to develop content for these different business lines.

Raise PCCW’s valuation on Media business, trim HKT on higher tax forecast. We now value each media business separately based on peer multiples, and we triple our total Media valuation, from HKD2bn to HKD6.3bn. For HKT (TP: HKD12.50), we raise our tax estimate, which we now believe was too low, reducing our DCF valuation by 5%. We expect continued benefits from mobile cost reductions, but limited re-pricing benefits in either mobile or residential broadband. Our PCCW forecasts are below consensus on profits, but we expect the market to look to the strong subscriber and revenue momentum in the new business. We expect the OTT business to move to EBITDA break-even in 2018. With continued pass-through of a growing HKT dividend, PCCW shareholders can be paid while the media growth story unfolds. We believe our 3x price-to-sales multiple for the OTT business is conservative. In our bull case scenario, ✔ Vote in Asiamoney Brokers Poll 2016 applying a 5x price-to-sales multiple results in a valuation per PCCW share of HKD6.50 4 July - 12 August If you value our service and insight, vote for HSBC – with OTT comprising 10% of the total – compared with 6% in our base case. Click here to vote

Hong Kong Telcos: key data Stock code Company Old TP New TP Change Old New 5-Jul price Upside Mkt cap Daily vol EV/EBITDA PE Div yield HKD HKD rating rating HKD USDm USDm FY16e FY16e FY16e 8 HK PCCW 5.20 6.30 21.2% Hold Buy 5.22 21% 5,007 5 5.7 14.5 4.2% 6823 HK HKT Trust 13.20 12.50 -5.3% Buy Hold 11.30 11% 10,925 12 9.5 19.0 4.9% Source: Company data, Bloomberg, HSBC estimates

Disclosures & Disclaimer Issuer of report: The Hongkong and Shanghai This report must be read with the disclosures and the analyst certifications in Banking Corporation Limited the Disclosure appendix, and with the Disclaimer, which forms part of it. View HSBC Global Research at: https://www.research.hsbc.com

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Contents

Investment summary 3

Media valuation 6

Over The Top: growth engine 10

Free-to-Air 16

Now TV 19

PCCW (8 HK) 23

HKT (6823 HK) 28

Appendix 33

Disclosure appendix 39

Disclaimer 43

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Investment summary

 Analysis of PCCW Media and its competitors leads to substantial change in view: believe content and market positioning is strong  Continue to see steady growth at HKT, but organic growth muted by strong competition in mobile and residential broadband  Revised Media valuation underpins 21% increase in PCCW SOTP valuation: upgrade to Buy; downgrade HKT to Hold on higher taxes

Media business – well-positioned

Following greater segment disclosure in the PCCW Annual Report we now value each component of the Media business separately. These are the core ‘Now TV’ pay-tv business, and the free-to-air ViuTV business (launched in April 2016) – both of which are primarily operating in Hong Kong. The Viu business is an ‘Over The Top’ (OTT) app and web-based platform, which delivers Asian content using a ‘freemium’ model: free access is supported by advertising revenue, while premium services and access is available to customers paying a subscription. Key costs are content, translation and dubbing.

 Viu: the ‘Over The Top’ business has strong growth momentum. Viu reached over 9m subscribers in more than 10 markets by March 2016. We believe it is clearly differentiated in terms of content, region and business model from its competitors – chiefly iflix and Hooq. We model EBITDA break-even in 2018, with negative EBITDA in the Media business weighing on our forecasts relative to consensus in 2016-18e.

 ViuTV Free to Air business: a market opportunity. Following the demise of ATV in April 2016, ViuTV has a clear market opportunity. Its fresh approach has been well-received, and we expect it to take a 20% share of TV advertising net spend in Hong Kong by 2020.

Media revenue to double by 2020e EBITDA contribution starts in 4 years 7,000 700 Now TV Viu ViuTV Now TV 600 6,000 Viu 500 400 ViuTV 5,000 300 200 4,000 100 0 3,000 -100 -200 2,000 -300 Dec-14 Dec-16 Dec-18 Dec-20 Dec-14 Dec-16 Dec-18 Dec-20 Source: Company data, HSBC estimates Source: Company data, HSBC estimates

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 Core ‘Now TV’ business remains solid. Our concern at the start of the year over OTT growth in Hong Kong (see our report of 8 January 2016, Game of Phones) has diminished as Now TV has expanded its content line-up and secured sports rights deals. We expect it to maintain its market share, with substitution by OTT only likely in certain niche markets. We model low single-digit growth in revenue, and a flat EBITDA margin at 16%.

These businesses share can share content, studio and human resources, enabling relatively low operating costs for a diverse business. This means PCCW can leverage its deals with the Korean studios across multiple platforms.

Solutions business – stable

We make no changes to our solutions business forecast in this report. This remains a difficult business to forecast, with a high degree of variability as a result of new contracts. We believe our forecasts are conservative: we assume a 2015-17 revenue CAGR of 5% (compared with 10% CAGR in 2013-15) and a 2015-17e EBITDA CAGR of 6% (compared with 15% between 2013 and 2015). PCCW notes that the business is relatively defensive, with corporate clients looking to save costs via outsourcing and solutions in a difficult economic environment.

In June 2016 PCCW Solutions launched the D-Infinitum Global Data Centre Alliance, covering 80 data centre facilities across 40 cities globally. We believe this should broaden the appeal of PCCW’s services, and look for more details at half-year results in early August.

HKT business – stable, but growth harder to come by

We continue to like the outlook for HKT Trust, which we expect to derive further cost savings as it integrates the CSL mobile business. We make no changes to our revenue and profit forecasts in this report, but after speaking to the different entities in Hong Kong we expect the organic growth outlook in mobile and residential broadband to remain muted. In mobile competition (particularly at the low end) remains tough, while in residential broadband HKBN (1310 HK – HKD8.20 – Buy – TP HKD12.50) has increased its subscriber growth target from 60,000 to 100,000 for FY ending August 2016 and 2017.

The sole adjustment we make is to our cash tax estimate, which we now believe was too low, and did not correctly reflect the using up of tax offsets accrued via the acquisition of CSL. This drives a reduction in our cash flow forecast, and thus the 5% reduction in our target price.

Hong Kong Telcos ______HSBCe vs consensus ______HSBCe vs prior estimates ______FY15e FY16e FY17e 2015e 2016e 2017e PCCW PCCW Sales 0.2% 0.7% -0.2% Sales 1.6% 3.1% 4.3% EBITDA -2.7% -5.2% -5.9% EBITDA -0.6% -1.5% 0.4% OP -2.4% -5.0% 0.3% OP -1.3% -3.1% 0.3% Net income 5.8% -1.6% 16.8% Net income -2.4% -5.9% 0.5% EPS 6.8% 0.0% 15.8% EPS -2.4% -5.9% 0.5% HKT Trust HKT Trust Sales 1.2% 1.4% 0.7% Sales 0.0% 0.0% 0.0% EBITDA -0.5% -2.0% -4.3% EBITDA 0.0% 0.0% 0.0% OP 2.3% -2.4% -9.0% OP 0.0% 0.0% 0.0% Net income 4.3% 0.1% -6.2% Net income 0.0% 0.2% 0.4% EPS 4.1% -0.5% -6.8% EPS 0.0% 0.2% 0.4% Source: Company data, Bloomberg, HSBC estimates

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Forecasts vs consensus, prior estimates

Our forecasts vs consensus and vs our prior estimates are outlined in the table below:

 PCCW. We raise our revenue forecasts and trim EBITDA due to our revised assessment of the Media business. Our revenue estimates are only in line with consensus – we believe – because of lower handset sales estimates at HKT Trust, while EBITDA is lower because of losses in the Media business.  HKT. We reduce our net income and EPS estimates slightly due to higher tax forecasts. We now assume USD87m in cash taxes payable in 2016. This compares to our prior forecast for USD47m.

Our valuation of the Media business increases 3x

PCCW, with a market cap of HKD38bn, holds a 63% stake in HKT Trust, with a market cap of HKD85bn. In this report, we reduce our HoldCo discount from 45% to 25% as we now assess ‘others and eliminations’ separately in our valuation. We believe this is more in line with the consensus approach. We adjust our sum-of-the-parts valuation for PCCW as follows:

 Media business. We forecast each component of the Media business separately. We apply a multiple of 6.7x EBITDA to the Now TV business, based on TVB. We apply a 2.8x price-to- sales multiple to the ViuTV FTA business, also based on TVB. We apply a 3x price-to-sales multiple to the Viu OTT business, based on recent transactions in China. Collectively, we derive a value for the Media businesses of HKD6.3bn, from HKD2.0bn previously.

 Solutions business. We continue to apply a multiple based on Infosys, applying 12.1x (11.3x previously) which values the solution unit at HKD6.2bn (HKD5.6bn previously).  HKT Trust. We continue to use a DCF-based valuation for HKT. This is reduced by 5% due to the impact of a higher tax forecast, due to the utilization of tax benefits following the acquisition of CSL.

Our PCCW valuation is outlined in the table below.

PCCW sum-of-the-parts valuation Business unit Valuation Ownership Enterprise value (HKDm) Per share (HKD) HKT Trust DCF 63.1% 126,402 17.24 Now TV (pay) EV/EBITDA @ 6.7x 100% 3,338 0.46 ViuTV (free) Price/Sales @ 2.8x 100% 334 0.05 Viu (OTT) Price/Sales @ 3x 100% 2,599 0.35 Solutions EV/EBITDA @ 12.1x 100% 6,231 0.85 PCPD Market value 71.7% (119) (0.02) Others and eliminations (10,596) (1.44) Net cash/(debt) (31,991) (4.36) Minority interests (34,815) (4.75) Equity value 61,383 8.40 Holdco discount 25% (15,346) (2.10) Equity value (post-discount) 46,037 6.30 Current market price (HKD) 5.22 Potential return 20.7% Source: Company data, HSBC estimates

Key risks to our positive view of PCCW are an acquisition deemed to be risky by the market, and a lower pass-through of the HKT dividend than investors expect. Key potential PCCW catalysts are strong growth in subscribers and revenue at half-yearly results in early August, as well as other new business subscriber and business milestone announcements.

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Media valuation

 Value each component of the Media business separately in this report, using peer multiple approach  Believe that Viu is well-positioned relative to peers, both in terms of content and flexible business model  ViuTV attractive as a relatively low-cost offering that provides an alternative to both audiences and advertisers in Hong Kong

Viu valuation approach: price-to-sales multiple

In common with other online video providers in Asia and globally, Viu is loss-making and is expected to remain so for the next two years. We forecast EBITDA break-even in 2018e. Given the differences in business model (advertising, subscription, or a combination of the two) we believe sales rather than accounts is the best metric.

Regional peers: iflix and Hooq Peer companies operating in the same region, with implied valuation multiples, are outlined below.  Iflix is a Catcha Group company in which Philippines incumbent PLDT (TEL PM – PHP2,136 – Hold – TP PHP2,100) has a 7.5% shareholding (valuing the company at USD450m in March 2016). Iflix aims to the be default source for high-value branded content in global emerging markets. It works with telco carrier partners to offer Western content (it is backed by NBC Universal). It operates on a subscription model – with subscriptions paid for by its telco partner or premium subscribers. Media (Business World Online, 8 April 2016) reported it as having more than 1m accounts by end-2015, and over 2m by end-February 2016. No revenue data is available. Assuming average revenue of USD1-2 per month per subscriber and subscriber growth to c8m by end-2016e implies cUSD70-140m in revenue in 2016, or a price-to-sales multiple of 3-6x.  Hooq is a SingTel Digital Life subsidiary, co-owned by Sony and Warner. It operates using a subscription model, which we believe has slowed its growth. SingTel is not releasing current subscriber numbers for Hooq, but local media (UpgradeMag, 20 March 2016) reported Hooq exceeded 100,000 paying subscribers in its first year in the Philippines. Very little valuation or other data is available for Hooq, which is at a relatively early stage of development.

China peers: Youku Tudou and iQiYi In China, we can look to two companies that provide a consistent price-to-sales multiple of c3x.

 iQiyi. 80.5% owned by Baidu (covered by Chi Tsang: BIDU US – USD 161.87 – Buy – TP USD199), iQiyi is the largest online video site in China. Its content library includes licensed and self-produced original content. Users can search and watch ad-supported content, while paying subscribers enjoy special benefits. In February 2016 Baidu disclosed that it had received a bid for its stake valuing the service at cUSD2.8bn. The offer is led by Baidu Chairman Robin Li and Qiyi CEO Yu Gong. iQiyi is one reason why content costs and bandwidth expense has increased substantially, by 125% and 81% y-o-y respectively.

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 Youku Tudou. In October 2015, Youku announced that it had received a ‘going private’ proposal from Alibaba (covered by Chi Tsang: BABA US – USD79.65 – Buy – TP USD113; an Asia Super Ten portfolio stock) in which it would acquire the Youku shares it did not own for an amount confirmed in November 2015 as USD27.60 in cash. This valued it at cUSD3.67bn, 5.1x estimated 2015e revenue at the time, and 3.6x 2016e revenue. Alibaba already held an 18% stake in the company prior to the offer. Youku holds a c21% market share of the Chinese online video market.

Global peers: Netflix and Hulu  Netflix. Netflix (not rated) launched in many Asian markets in a co-ordinated launch early in 2016. However, our discussions with operators suggest it has seen limited traction outside markets such as Australia, where its English-language, US-oriented content is both widely known and does not need subtitling. In markets such as Japan, Hong Kong and Singapore our discussions with the telcos suggest demand for Netflix has been offset by the lack of key exclusive content, and by the lack of local content. In Hong Kong, the Netflix-produced ‘House of Cards’ is available on PCCW’s Now TV, but not – due to licensing issues – on the Hong Kong Netflix platform. Netflix trades at 6.1x trailing 2015 sales, and 4.7x 2016e sales. It booked a margin of 7% on sales of USD493m in 2015 (chart below). In 1Q16, Netflix said non-US residents accounted for 4.5m of its 6.7m new subscribers (after extending its service to more than 130 markets in January 2016) and 42% of its 81.5m subscribers.

 Hulu. Hulu (not listed) is a joint venture of Disney, Fox and NBC/Comcast. It offers a selection of TV shows, clips, movies and other streaming media on Hulu.com. Hulu offers a monthly subscription fee service across multiple platforms. Like Netflix, Hulu has expanded overseas, but with mixed results. In 2013 Nippon TV acquired Hulu’s Japan business, after a troubled standalone launch due to the lack of local content. In May 2016 Hulu announced it had 12m subscribers, from 9m in May 2015. Revenue is not disclosed.

OTT valuation sensitivity

In our view, the business model of the Viu service has much to recommend it:

 Flexible business model. Unlike iflix, Netflix and Hooq, Viu has both a ‘freemium’ and a subscription based revenue model. This is particularly important in low-income markets.  Relatively low content costs. Unlike iQiyi, Viu content is likely to be viewed mostly on mobile. Its compression technology ensures that bandwidth charges should be relatively low.

Netflix EBITDA, USDm, margin

600 15% 13% 500 11% 400 9% 300 7% 5% 200 3% 100 1% 0 -1% 2008 2009 2010 2011 2012 2013 2014 2015 2016 EBITDA, USD m % margin

Source: Company data, Thomson Reuters

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 Focused content. Unlike Hulu and Netflix, which have struggled due to their focus on Hollywood and TV shows, Viu has a clear target market of Asian consumers looking for Asian content. This is reinforced by selected local content, enabling it to compete in markets such as India.

We apply a multiple of 3x 2016e revenue, taking the recent transactions in China as our baseline. This is a discount to the implied valuation of Netflix.

Peer company price-to-sales multiples TVB Netflix iQiyi ZEE DISH Comcast Youku P/Sales 2.8 4.7 3.0 6.8 1.0 1.7 3.0 Source: Company data, HSBC estimates

The table below illustrates the impact of the OTT business on our valuation, with the contribution to the valuation varying between 6% in our base case and 10% in our bull case, and 2% in our bear case.

OTT valuation: base, bull and bear case Base Bull Bear Viu business 2016e revenue 866 977 762 2015-20 CAGR 39% 44% 34% Price-to-sales multiple 3.0 5.0 1.0 Valuation, HKD 2,599 4,883 762 Valuation, USD 335 629 98 PCCW sum-of-the-parts target price 6.30 6.50 6.10 Contribution per share, HKD 0.35 0.67 0.10 Contribution per share, % 5.6% 10.2% 1.7% Source: Company data, HSBC estimates

The table on the next page illustrates the assumptions underpinning each of these scenarios for key performance indicators.

OTT revenue, HKDm: base, bull and bear OTT EBITDA, HKDm: base, bull and bear case case

3,000 250 200 2,500 150 2,000 100 50 1,500 - 1,000 (50) (100) 500 (150) - (200) Dec-15a Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-15a Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Base Bull Bear Base Bull Bear

Source: Company data, HSBC estimates Source: Company data, HSBC estimates

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OTT KPIs: base, bull and bear case scenarios Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 BASE CASE Viu accounts, 000s 7,600 9,000 11,500 14,000 17,500 21,000 9,000 14,000 21,000 24,000 26,500 28,500 Viu net additions, 000s – 1,400 2,500 2,500 3,500 3,500 – 5,000 7,000 3,000 2,500 2,000 Viu ARPU, HKD 3.62 5.36 6.00 6.50 7.10 7.10 – 6.28 7.10 7.00 6.94 6.90 Change y-o-y 0.0% 0.0% 65.8% 21.2% 18.3% 9.2% 0.0% 0.0% 13.1% -1.4% -0.9% -0.5%

Revenue 165 267 369 497 671 820 432 866 1,491 1,890 2,101 2,276 Change y-o-y 17.0% 42.8% 123.6% 86.2% 81.8% 64.9% 31.7% 100.5% 72.1% 26.8% 11.2% 8.3%

EBITDA (17) (41) (45) (47) (47) (40) (58) (92) (87) 19 68 112 Change y-o-y 1600.0% 127.8% 164.5% 14.2% 4.2% -14.8% 205.3% 58.2% -5.5% -121.8% 261.3% 64.6% Margin -10.3% -15.4% -12.2% -9.4% -7.0% -4.9% -13.4% -10.6% -5.8% 1.0% 3.3% 4.9%

BULL CASE Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Viu accounts, 000s 7,600 9,000 12,000 15,000 19,000 23,000 9,000 15,000 23,000 26,500 29,500 32,000 Viu net additions, 000s – 1,400 3,000 3,000 4,000 4,000 – 6,000 8,000 3,500 3,000 2,500 Viu ARPU, HKD 3.62 5.36 6.50 7.00 7.60 7.60 – 6.78 7.60 7.50 7.41 7.33 Change y-o-y 0.0% 0.0% 79.6% 30.6% 16.9% 8.6% 0.0% 0.0% 12.1% -1.3% -1.2% -1.1%

Revenue 165 267 410 567 775 958 432 977 1,733 2,228 2,490 2,704 Change y-o-y 17.0% 42.8% 148.2% 112.4% 89.3% 68.9% 31.7% 126.0% 77.5% 28.5% 11.8% 8.6%

EBITDA (17) (41) (47) (47) (41) (27) (58) (94) (68) 22 112 193 Change y-o-y 1600.0% 127.8% 178.5% 14.0% -12.6% -42.7% 205.3% 62.2% -27.6% -132.7% 403.0% 72.0% Margin -10.3% -15.4% -11.6% -8.2% -5.3% -2.8% -13.4% -9.6% -3.9% 1.0% 4.5% 7.1%

BEAR CASE Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Viu accounts, 000s 7,600 9,000 11,000 13,000 16,000 19,000 9,000 13,000 19,000 21,500 23,500 25,000 Viu net additions, 000s – 1,400 2,000 2,000 3,000 3,000 – 4,000 6,000 2,500 2,000 1,500 Viu ARPU, HKD 3.62 5.36 5.50 6.00 6.60 6.60 – 5.77 6.60 6.50 6.46 6.45 Change y-o-y 0.0% 0.0% 52.0% 11.9% 20.0% 10.0% 0.0% 0.0% 14.3% -1.5% -0.6% -0.1%

Revenue 165 267 330 432 574 693 432 762 1,267 1,580 1,744 1,878 Change y-o-y 17.0% 42.8% 100.0% 61.8% 74.0% 60.4% 31.7% 76.4% 66.3% 24.6% 10.4% 7.7%

EBITDA (17) (41) (46) (56) (67) (74) (58) (102) (141) 16 33 51 Change y-o-y 1600.0% 127.8% 173.5% 35.7% 45.0% 32.6% 205.3% 76.1% 38.3% -111.2% 109.8% 53.6% Margin -10.3% -15.4% -14.1% -12.9% -11.7% -10.7% -13.4% -13.4% -11.1% 1.0% 1.9% 2.7% Source: Company data, HSBC estimates

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Over The Top: growth engine

 See Viu OTT business as clearly differentiated from peers, with a strong content base, and global appeal for Asian consumers  Derive a value of HKD2.6bn (cUSD335m) on strong growth prospects – based on a conservative 3x price-to-sales multiple  Expect EBITDA break-even in 2018 – potential catalysts are strong subscriber and revenue growth in the near term

Investment summary

Our research into the Viu OTT business suggests it is in a strong position. It has a clearly defined market position, with the aim of being the default source for Asian content. Its initial target markets are in Asia, but potentially it can target Asian consumers globally. Having begun as a subscription-only service, it is now evolving into a ‘freemium’ revenue model that enables it to be flexible and sign up larger numbers of customers. It also has compression technology that supports rollout in markets where 3G and 4G coverage is still limited. The OTT segment booked a loss of HKD58m in 2015, on revenue of HKD432m. OTT was 13% of overall Media in 2015, and we forecast it to be one-third by 2018. We forecast a 2015-17e revenue CAGR of 86%, on strong subscriber expansion. Catalysts are strong subscriber figures as Viu moves into new markets, followed by strong revenue growth at results announcements.

Viu: key markets

Source: PCCW

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Media segment contribution – OTT to be one-third by 2018e 100%

80%

60%

40%

20%

0% Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Now TV (pay) Viu (OTT) ViuTV (free)

Source: Company data, HSBC estimates

Viu: market positioning

Since PCCW acquired VuClip in 2015, it has focused on high-value Asian content – particularly from Korea. Its brand proposition to consumers is to the gateway to Asian content – particularly dramas and music from Korea, China and India. In our view, this clearly differentiates it relative to its competition, which are much more focused on Hollywood content:

 Iflix. Iflix is a Catcha Group company, in which Philippines incumbent PLDT has a 7.5% shareholding (valuing the company at USD450m in March 2016). Iflix aims to the be default source for high-value branded content in global emerging markets. It works with telco carrier partners to offer Western content (it is backed by NBC Universal). It operates on a subscription model – with subscriptions paid for by its telco partner or premium subscribers. Media reported it as having over 1m accounts by end 2015, and over 2m by end February 2016.

 Hooq. Hooq is a SingTel Digital Life subsidiary, co-owned by Sony and Warner. It operates using a subscription model, which we believe has slowed its growth. SingTel is not releasing current subscriber numbers for Hooq but local media (UpgradeMag) reported Hooq has reached over 100,000 paying subscribers in its first year in the Philippines.  Netflix. Netflix launched in many Asian markets in a co-ordinated launch early in 2016. However, our discussions with operators suggest it has seen limited traction outside markets such as Australia, where its English-language, US-oriented content is both widely known and does not need subtitling.

 Pirate content. In many markets, users access pirated content. However, subtitling or dubbing is often poor, while files require reformatting, download over Wi-Fi etc. Each of Viu, iflix and Hooq is aiming to be a better, easier option than pirating for the majority of Asian consumers.

Viu has seen strong uptake since its October 2015 launch:

 Market presence. It has now expanded to more ten markets, from six in March 2015 when PCCW acquired VuClip.

 Subscribers. It nearly doubled its subscribers to 9m by March 2016 in one year, according to PCCW Media.

 App downloads / video views. Central to the October 2015 relaunch as Viu was the app. This has been popular in Hong Kong (1.2m downloads by early April 2016) and Singapore (400k downloads by February 2016 after launch in December 2015. In February 2016 Viu was recording 4m monthly video views in Hong Kong and 2m in Singapore.

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Content holdings

Viu content

Source: PCCW

Korean content – exclusive rights to 95% of latest dramas Korean content – particularly drama – is the mainstay of Viu’s cross-market appeal. In 2016, an Acorn study commissioned by PCCW Group found that 53-80% of viewers surveyed across Singapore, Malaysia and Jakarta watch Korean drama on a regular basis.

While drama is a major draw (the current favourite is Descendants of the Sun) Korean studios have proven adept at using music to cross-sell other Korean artists – many of whom are popular outside Korea in their own right. In Japan for instance Korean artists are now more popular than domestic artists.

We see limited risk that the ‘hallyu’ Korean wave will end any time soon. This type of content has proven enduringly popular for Asian consumers, and over the long-term as well. Initial success was recorded (in Japan in particular) with the ‘Winter Sonata’ series in 2002. One reason for this is that the Korean studios have been adept at tapping into broad-based emotions and sentiment – their appeal is not contingent on an enthusiasm for Korean culture alone.

In January 2016 PCCW Media signed ‘output’ agreements with the drama studios of four top Korean broadcasters: SBS, KBS, MBC, and CJ E&M. This gives Viu exclusive rights to 95% of their latest dramas and variety shows from South Korea. From their perspective, a deal with PCCW offers an easy way to target multiple markets – we expect the benefits for these studios to increase as Viu expands to other markets (the current deal is for 8 markets). This amounts to c4,000 hours of new content per year, as well as access to a library of c4,000 hours.

OTT TV in Hong Kong OTT Content focus Monthly tariff (HKD) Contract period ViuTV Local reality shows and entertainment Free of charge N/A programmes Viu Korean dramas, other Chinese and Asian $38 (premium)* or $39 (data pass 12-month content bundle) myTV Local dramas (5 channels from TVB) Free of charge N/A myTV Super myTV + other Asian dramas and variety shows, $38 (app) or $68 (set top box) 12-month movies and Japanese anime Netflix Europe and US dramas and Netflix original $63 (basic), $78 (standard) or $93 No series (premium) LeEco Sports (i.e. EPL), HK and Chinese dramas and $499 (set top box) N/A movies *HKT-CSL customers only HKD8/month for Viu premium Source: HSBC

Top programmes available at launch include popular variety shows: Running Man and The Return of Superman as well as newly released dramas Remember, Moorim School, and Descendants of the Sun staring Song Hye Kyo and Song Joong Ki, Happy Ending Once Again, and Signal. K-pop shows include Music Bank and Inkigayo.

Korean content is processed and distributed by PCCW according to the needs of each platform. So the latest drama might be available on the Viu app just 4-8 hours after telecast in Korea, with

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PCCW Media employees working hard to subtitle the episode for die-hard fans who may be accessing the content in the early hours. The same content is later dubbed for Now TV and ViuTV (dubbing is a regulatory requirement for FTA broadcasts). FTA will be the last platform to get the content, but has a target audience of viewers who are not as time-sensitive.

Indian content Viu’s approach to Indian content is different from that of iflix, which has opted not to launch in the market. Iflix notes that competition is intense, with many different entities. PCCW believes that while the challenges are substantial (not least the 13 different dialects), it can resell much of its Indian content to Indian communities elsewhere – such as Singapore and Malaysia in Asia. We believe Viu has a stronger brand as a provider of Korean content rather than Indian.

For the Viu relaunch in India in March 2016, PCCW has negotiated access to thousands of hours of local content. These include: Reliance Big Entertainment PVt Ltd, Sony Music, BBC Worldwide, Zee Digital Convergence, Tips Industries Ltd, Balaji Motion Pictures, Rajshri Entertainment, Unisys Infosolutions, Shemaroo, Anand Audio, etc. The content includes over 17,000 hours of “First on Viu Bollywood” Indian movies and the latest music videos in India. In addition, Viu launched a Viu Originals’ chat show, “What the Duck”, co-created with Fluence, CA Media Digital’s celebrity network. Hosted by standup comedian, cricket humorist and author Vikram Sathaye, each of the 10 episodes of the series features a cricket celebrity with anecdotes and stories.

Viu business model

The Viu business has two revenue models:

 VuClip – premium. When PCCW acquired the business in 2015, VuClip operated using a premium, video-on-demand basis, with subscribers billed for access via the carrier partner.

 Viu – ‘freemium’. Following the re-launch as an OTT business, Viu operates a ‘freemium’ model. Basic access (with advertising) is free, with premium content, downloads and other services available on a charged basis.

Content partnerships PCCW Media has signed up several important content partnerships for distribution. This includes content that is distributed across most of the platform (such as Korean studio output) and content that is primarily for a single market (India is a good example).

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Viu business model

Source: PCCW

Multi-use strategy A key plank of PCCW Media strategy is to re-use content across multiple platforms, for multiple audiences and demographics. Its deployment of its Korean content is a good example of this:

 Rapid sub-titled release after local telecast. PCCW Media has a team tasked with translation and dubbing. Until Jan / Feb 2016, sub-titled Korean dramas were available on the Viu OTT app eight hours after telecasting in Korea. By March 2016, this had been shortened to just four hours. The target demographic here is hard-core – usually younger – fans who watch via the Viu app (the episodes are often posted at 1am / 2am local time, but still get considerable traffic from die-hard fans).

 Dubbed release on ViuTV. The regulator requires that content on ViuTV is dubbed rather than sub-titled. This takes longer, but enables PCCW to target a different demographic who follow Korean dramas but in a more traditional free-to-air format.  Video-on-demand. The deals with the studios also include the content library, which should help boost the content for both Now TV and Viu.

Revenue growth to accelerate in 2016e EBITDA to breakeven in 5 years

2,500 120% 100 5%

2,000 100% 50 0% 80% 1,500 0 60% -5% 1,000 -50 40% -10% 500 20% -100 0 0% -150 -15% Dec-14 Dec-16 Dec-18 Dec-20 Dec-14 Dec-16 Dec-18 Dec-20 Revenue (HKDm) % y-o-y EBITDA (HKDm) % margin Source: Company data, HSBC estimates Source: Company data, HSBC estimates

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Financial outlook

 Revenue. The OTT business booked HKD267m in revenue in 2H15 (up 43% y-o-y). This also reflects the early growth of the re-launched Viu OTT service and app. This implies revenue of HKD5 per month per account. In practice, this will be split between a small proportion of customers paying for Premium access, and a much broader base of advertising revenue against a rapidly growing user base. Premium models vary – in Hong Kong, a customer can choose to pay HKD38 per month for a premium subscription or HKD39 per month for the data pass bundle offer (including Viu Premium Service and mobile data consumption when watching or downloading videos using the Viu app), with both subject to a 12-month contract period. Viu also has some ‘zero rate’ deals with operators, who choose to pay Viu subscription fees for their high-value customers in exchange for the big pick-up in data revenue.  Marketing costs. Viu works with advertisers such as Yahoo!, which doesn’t have its own content. It states that advertising has been relatively minimal – the popularity of the app download was largely due to word-of-mouth as well as high ranking on the Google Play and Apple App stores.  Content costs. PCCW uses Amazon Web Services (AWS) to host content, as well as its own CDN in Hong Kong. This contrasts with iflix, where all content is stored on the network of the carrier partner to minimize external network costs. We see minimal capex relating to this business, with most infrastructure costs rented on a capacity basis.

Video revenue breakdown in 2014 – OTT extremely underdeveloped 100%

80%

60%

40%

20%

0% VT SG PH TH MY ID HK IN NZ CH JP AU KR TW Free-to-air Pay OTT

Source: Media Partners Asia, HSBC

As the chart below illustrates, Hong Kong, Indonesia and Malaysia are believed to have strong growth prospects.

. Regional OTT video revenue (USDm) 2014-20e CAGR (%) by country

300 70% % CAGR 2014-20 250 60% 200 50% 40% 150 30% 100 20% 50 10% 0 VT SG PH TH MY ID HK IN* 0% 2014 2020 HK VT SG ID MY IN TH PH

Source: Media Partners Asia, HSBC estimates Source: Media Partners Asia, HSBC estimates Note: India is USD1333m in 2020e

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Free-to-Air

 The free-to-air channel ViuTV was launched in April and has been well-received by audiences and advertisers  Opportunity in a duopoly market as ATV fades and i-Cable takes a go-slow approach: costs shared across Now TV and OTT platforms  Forecast revenue to grow ten-fold by 2020 and forecast ViuTV to take 20% of the TV advertising market by 2018

Investment summary

We see ViuTV a disrupter in the Hong Kong free-to-air TV market. PCCW Media Group has managed the launch of ViuTV business prudently, with production resources shared between the Now TV, FTA and OTT businesses. The Head of ViuTV is ex-Apple and has been aiming for popular shows in new content areas: it is not trying to compete with TVB’s core drama content. ViuTV will launch an English channel by March next year. The English language market is much smaller in Hong Kong given wide availability of generic content and PCCW will try to deliver localized data in a cost-efficient way. We forecast the FTA business to book revenue of HKD119m in 2016e which will be 3% contribution to overall Media unit. We forecast a 2016-18e revenue CAGR of 136% on strong take up in the local TV ad spend market.

Market structure – Viu TV creates an attractive duopoly

The domestic free TV market has been in a duopoly structure with only two players TVB and ATV since 1978 (after the collapse of Commercial Television). In 2009, the Hong Kong government decided to increase the number of licensees and subsequently have granted to PCCW (via HKTVE) and i-Cable (via Fantastic TV) a domestic free TV programme service licence. However, with ATV’s shut down and i-Cable’s slow-go approach, we see the duopoly market structure will remain which should provide ViuTV a window of opportunity to aggressively compete with incumbent TVB.

ATV – The Chief Executive has decided not to renew ATV’s domestic free TV programme service licence and ATV has been shut down since April 2016.

i-Cable – We do not see the FTA unit at i-Cable as a substantial risk to ViuTV. While the HK government has officially granted i-Cable a domestic free television programme service licence (via its affiliate Fantastic Television Limited), this doesn’t come as a surprise (as the grant in principle was given to both PCCW and i-Cable at the same time). We believe that Wharf is not actively investing in this business and i-Cable may have had to go ahead with the application to keep the licence “live”. In Wharf’s annual result in 2015, the company announced a strategic review to evaluate different options of its Communications, Media and Entertainment segment which includes both Wharf T&T and i-Cable. More recently, Reuters has reported Wharf is seeking bidders for its USD1bn-plus telecoms unit. Therefore, with the lack of support and

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resources from parent group and a loss-making pay TV unit, we think i-Cable will struggle to compete in the FTA market.

HKTV – Hong Kong Television Network Limited (HKTV) has submitted to the CA an application for a domestic free TV licence in 2009 but was rejected in 2013. Since then operations of HKTV was adversely affected and it dismissed 320 staff at that time. HKTV made another application and the CA has been examining various aspects of the licence application as well as conducted a public consultation exercise. There is no visibility as to when will HKTV be potentially granted a FTA licence.

Approach is designed to minimize ViuTV costs

So far ViuTV has been focusing on reality shows while other TV channels (i.e. TVB) focus more on dramas. ViuTV comments in its launching ceremony in April this year that its advertisement slots were nearly full. In the future we believe ViuTV will negotiate with ad firms with combined viewership (both digital and online with TV viewership) to have better bargaining power and terms (i.e. current terms based solely on TV viewership). While ViuTV doesn’t have any viewership or revenue target at this moment, the General Manager Mr Lo aims to achieve higher overall Hong Kong TV viewership than current level. With this ambition, we see ViuTV’s initial focus is on quality of shows in order to build sustainability and credibility with advertisers.

 Capex – ViuTV will invest HKD2.7bn in 12 years (HKD1.4bn in first 6 years) with two channels. This contrasts with TVB’s investment of HKD6.3bn with five channels.  Infrastructure – ViuTV currently doesn’t have any plan to build a TV city of video factory as we believe initial focus is on operational experience (focus on reality and entertainment TV programs rather than TV drama series) in order to build credibility with ad firms.

 Competition and partnership – ViuTV welcomes competitors like TVB and i-Cable as it aims to shape the overall ecosystem and consumer behaviour. It also welcomes cooperation with other parties like HKTV and Netflix, and sees OTT/internet TV services more a complement to traditional TV dramas rather than a direct substitute.

PCCW has appointed Mr. Lo Ting Fai the head of its free TV unit. Mr Lo has a diverse background in advertising and creative media and has joined PCCW 6 years ago as a senior Vice President for strategy before becoming the General Manager of ViuTV. He was the Asia- Pacific Creative Director with Apple and has global advertising experience with other multinational firms.

Hong Kong ad spend to decline in 2016 Ad spend breakdown – TV still dominates

50,000 20% TV 15% 45,000 10% 13% Newspaper 40,000 5% 3% 31% Magazine 0% 10% 35,000 -5% Radio -10% 30,000 4% -15% Interactive 9% media 25,000 -20% Mobile

30%

Dec-11 Dec-13 Dec-14 Dec-15 Dec-16 Dec-12 Outdoor Total ad spend (HKDm) % y-o-y

Source: Admango, HSBC estimates Source: Admango, HSBC estimates

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Financials

Given that ViuTV was launched in April 2016 the business booked no revenue and an EBITDA loss of HKD40m in 2015. Like TVB’s FTA business, ViuTV generates all revenue through advertising income and this will depend on viewership as well as popularity of its TV shows (i.e. sustainability and credibility with advertising firms). Advertising revenue in Hong Kong has declined as consumer sentiment turns negative. Year-to-date, Admango estimated the overall ad spend in Hong Kong has dropped by 14% y-o-y. TV has been a dominate share of overall advertising spend at 31% and we forecast TV ad spend to decline by 16% in 2016e versus 2015. We assume ViuTV can take a 4% market share of net TV advertising spend which results in HKD120m revenue (i.e. net spend has been at a 70% discount to gross spend). We forecast ViuTV revenue to grow ten-fold to HKD1.2bn by 2020 as it gradually captures market share from the incumbent, with advertisers choosing to split their spending between TVB and ViuTV. We expect the business to breakeven by 2019-20e.

ViuTV revenue to grow ten-fold by 2020 ViuTV to breakeven in 4-5 years

1,200 250% 150 20%

1,000 200% 100 0% 800 50 -20% 150% 600 0 -40% 100% 400 -50 -60%

200 50% -100 -80%

0 0% -150 -100% Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 ViuTV revenue (HKDm) % y-o-y EBITDA (HKDm) % margin Source: Company data, HSBC estimates Source: Company data, HSBC estimates

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Now TV

 Business model is under more pressure …  … but expect Now TV to defend subscribers, revenue and earnings relatively well, with new content and new hardware  Growth in 4k content is a long-term driver

Summary: less impact from competition than we feared

In January 2016 we downgraded PCCW stock from Buy to Hold, in large part because of threats to the Now TV business. Six months on, our view has evolved: while we still believe that PCCW’s Pay TV business model is under threat, we expect limited disruption in the near term. The company has moved quickly to offset some of the risks: signing a deal with LeEco for the EPL (English Premier League) soccer content, and also moving to work with Netflix and TVB. It has also begun to position itself for a 4K world – its ‘One’ set top box (as well as integrating the multiple different sources of content available to HK consumers now) is 4k ready – with PCCW subsidiary HKT claiming superior ability to carry 4k content.

In Hong Kong, the pay TV market has been fully liberalized since 2000 and there are currently three domestic pay TV operators – i-Cable (1097 HK, NR), PCCW and TVB (511 HK, NR) and together they provide a total of 395 channels (with 83 HDTV channels). Pay TV services are subject to less content regulation and operators provide their services through multiple transmission means (i.e. hybrid fibre coaxial cable, microwave, satellite, broadband, etc.)

Declining Pay TV penetration but Now TV continues to gain market share 105% 2,200 100% 1,800

1,400 95% 1,000 90% 600 200 85% Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Now TV i-Cable TVB % household penetration Source: Communication Authority, Company data, HSBC estimates

Growing competition and OTT cannibalization has resulted in substantial loss of subscribers to i-Cable, while TVB remains a sub-scale player in this market. We forecast the overall pay TV market in Hong Kong to shrink with household penetration rate declining from 100% in 2014 to 90% in 2017e. Despite this, we believe Now TV should continue to gain market share at the expense of i-Cable and TVB and forecast Now TV to grow its share by 1.5% in 2016e (net additions of 10K).

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We forecast ARPU to rise steadily in the near term (+2% in 2016-17e) based on continued subscriptions to high-value content, but expect that margins will likely decline as Now TV spends more on marketing (i.e. partnership agreements with OTT companies, and advertising its new integrated set top box).

Now TV ARPU to grow steadily Now TV margin declining gradually

210 10% 510 18.5% 8% 200 500 18.0% 6% 190 17.5% 4% 490 180 2% 17.0% 480 170 0% 16.5% -2% 470 16.0% 160 -4% 150 -6% 460 15.5% Dec-08 Dec-10 Dec-12 Dec-14 Dec-16 Dec-13 Dec-15 Dec-17 ARPU (HKD) % y-o-y EBITDA (HKDm) % margin

Source: Company data, HSBC estimates Source: Company data, HSBC estimates

Limited impact from loss of English Premier League exclusivity

With LeEco’s (formerly LeTV) acquisition of the EPL soccer rights for the next 3 seasons, Now TV lost its soccer exclusivity. However, it moved quickly to secure broadcast rights, so the question is the number of customers who will leave Now TV to get cheaper access via HKBN (a substantially cheaper combination for broadband and soccer – at least HKD116 cheaper than Now TV).

 Now TV still retains the content. In the past (2010-13 EPL), Now TV lost coverage entirely to i-Cable which resulted in a 5% dip in ARPU but Now TV was able to grow net additions by 182K during the period (vs 89K at i-Cable), suggesting limited impact. While LeEco has some premium content such as soccer deals, other content (sports or otherwise) is mostly from the mainland, meaning it is of limited appeal to a Hong Kong or Western audience.  Now TV has exclusives in other areas. For soccer fans, Now TV offers La Liga, while for other sports (tennis, golf, etc.), Now TV is still the ‘one-stop shop’ in Hong Kong.

Consequently, it seems that HKBN will see the strongest take-up among either a) die-hard soccer fans who don’t care for other content, or b) customers who are interested in EPL but have not wished to pay for a full Now TV subscription.

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Now TV net additions 70 Now TV EPL i-Cable TV EPL Net adds (000s) 60 Now TV EPL 50 40 30 LeEco EPL 20 10

0

Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-07 Source: Company data, HSBC estimates

EPL impact on net additions EPL Bidder Net adds (000s) Net adds (000s) 2004-2007 i-Cable Now TV i-Cable 2007-2010 Now TV 243 214 2010-2013 i-Cable 182 89 2013-2016 Now TV 121 -138 2016-2019 LeEco 21 N/A Source: Company data, HSBC estimates

Alternative content sources – TVB and Netflix

TVB (511 HK, NR) has made a push into OTT content recently. We believe this could represent a larger risk to Now TV’ subscription revenue, as it creates a competing service to Now TV that is available at a much lower cost and has a broader market appeal than English soccer league.

TVB re-launched its pay-TV service in 2014 under a new brand, changing the name from TVB Pay Vision to TVB Network Vision. TVB Network Vision’s channels are carried by PCCW’s Now TV service due to a carriage agreement dating from launch. This is booked as associate income, and has been loss-making due to TVB incurring the entirety of costs for the content, but sharing the revenue with Now TV.

This prompted the development of an OTT alternative – myTV Super. It aims at more than 1.4m number of ‘screens’ by Nov 2017, through partnerships with Hutchison Telecom Hong Kong (215 HK, NR) and HKBN. TVB notes that this will not cannibalize its free-to-air (FTA) business as c20-21% of the overall advertising market is related to FTA, while the OTT business is targeting the 9% advertising market share booked by Internet companies. Additionally the OTT service is likely to attract a different demographic from the core (often older) FTA viewer.

 Set-top box model. Boxes are available either through distributors or as part of a broadband deal with the telcos (TVB targets 550k telco box sales by November 2017). The retail price of HKD68 per month is typically absorbed by the telco for new subscribers, as is the cost of the box (HKD780 in Hong Kong retail stores). The price of subscription via the app is HKD38 per month.

 Content. TVB has included the Network Vision channels as well as additional content – such as that from Disney international. It aims to rapidly expand the content – unlike the Network Vision business model, the more the better for TVB. It also plans to add 4k content.

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TVB has a solid following in Hong Kong, and its launch of an OTT offer is an extension of this. We see little cannibalization risk, but note that the service lacks the sport line-up of Now TV, as well as the range of Hollywood and foreign content offered.

By contrast, Netflix (NFLX US, NR) is believed to have made a slow start in Hong Kong. Its launch across multiple Asian markets commanded media headlines in January 2016, but it – English speaking markets like Australia excepted – has struggled due to lack of local content, limited availability of premium content (such as House of Cards), and limited subtitling. HKBN noted that Netflix related traffic is a tiny component of its total, while Now TV recently partnered with Netflix to host it on their ‘One’ set top box.

Set top box strategy – and the move towards 4K

In February 2016, PCCW subsidiary HKT highlighted the strengths of its network, with 4K content expected to grow from 2017 onwards. Now TV has developed its ‘One’ set-top box in collaboration with Samsung to be 4K ready, and to solve for the multiple set top boxes and online subscriptions that customers are increasingly dealing with.

We believe that Hong Kong – along with Korea – will be one of the early markets to embrace 4K content, due to the high average speed of broadband services: in both markets two-thirds or more of broadband subscriptions have speeds of 100Mbps or more. In Hong Kong, HKT believes that its content delivery network and broadband architecture will better handle the demands of super high-definition content and high traffic. Its current average daily usage and network loading is among the highest in the region.

Conclusion

We believe that Now TV’s position as the incumbent provider of pay television services in Hong Kong will remain. It does face more competition, but we do not believe most subscribing households can replace their pay TV services with online or OTT sources yet or any time soon. Now TV has also moved to offset the competitive risk: it is well-placed to benefit in the move to super high definition content, with its ‘One’ set top box consolidating its position as the de facto provider to high-income households in Hong Kong.

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PCCW (8 HK)

 Change PCCW HoldCo discount calculation to bring it more in line with the consensus approach  Triple Media business valuation to HKD6bn as we value each business unit separately, following improved disclosure from PCCW  Upgrade from Hold to Buy (TP to HKD5.20 from HKD6.30): like stable dividend outlook and option for growth in the Media business

Investment summary

Impressed at the positioning and growth prospects of PCCW Media. We have done a deep dive on the Viu OTT business, and believe its focus on Asian (particularly Korean) media means it is clearly differentiated from its peers (iflix, Hooq and Netflix). It had over 9m subscribers in more than 10 markets to its ‘freemium’ model by March 2016, and we expect rapid growth in revenue to become a key driver for PCCW’s stock price. The ViuTV Free To Air (FTA) channel launched in April, and has been well-received by both audiences and advertisers. Earlier in 2016 we were worried that the Now TV business was at risk from the growth of OTT content in Hong Kong. However, it has moved swiftly to shore up its position with new content, and we expect it can successfully defend its existing subscriber base. We expect PCCW to benefit from economies of scale and scope as it pools staff and resources to develop content for these different business lines.

Raise PCCW valuation on media business, trim HKT on higher tax forecast. We now value each media business separately based on peer multiples, and nearly quadruple our total Media valuation from HKD2bn to HKD6bn. Our PCCW forecasts are below consensus for profits, but we expect the market to look to the strong subscriber and revenue momentum in the new business. We expect the OTT business to move to EBITDA break-even in 2018. With stable pass-through of a growing HKT dividend, we believe PCCW shareholders will be paid to wait for the media growth story to unfold.

Valuation and rating

PCCW, with a market cap of HKD38bn, holds a 63% stake in HKT Trust, with a market cap of HKD85bn. In this report, we reduce our HoldCo discount from 45% to 25% as we now assess ‘others and eliminations’ separately in our valuation. We believe this is more in line with the consensus approach.

We adjust our sum-of-the-parts valuation for PCCW as follows:

 Media business. We forecast each component of the Media business separately. We apply a multiple of 6.7x EBITDA to the Now TV business, based on TVB. We apply a 2.8x price- to-sales multiple to the ViuTV FTA business, also based on TVB. We apply a 3x price-to-

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sales multiple to the Viu OTT business, based on Netflix. Collectively, we derive a value for the Media businesses of HKD6bn, from HKD2.0bn previously.  Solutions business. We continue to apply a multiple based on Infosys, applying 12.1x (11.3x previously) which values the solution unit at HKD6.2bn (HKD5.6bn previously).

 HKT Trust. We continue to use a DCF-based valuation for HKT. This is reduced by 5% due to the impact of a higher tax forecast, due to the utilization of tax benefits following the acquisition of CSL.

PCCW Sum-of-the-parts valuation table Business unit Valuation Ownership Enterprise value Per share (HKD) (HKDm) HKT Trust DCF 63.1% 126,402 17.24 Now TV (pay) EV/EBITDA @ 6.7x 100% 3,338 0.46 ViuTV (free) Price/Sales @ 2.8x 100% 334 0.05 Viu (OTT) Price/Sales @ 3x 100% 2,599 0.35 Solutions EV/EBITDA @ 12.1x 100% 6,231 0.85 PCPD Market value 71.7% (119) (0.02) Others and eliminations (10,596) (1.44) Net cash/(debt) (31,991) (4.36) Minority interests (34,815) (4.75) Equity value 61,383 8.40 Holdco discount 25% (15,346) (2.10) Equity value (post-discount) 46,037 6.30 Current market price (HKD) 5.22 Potential return 20.7% Source: Company data, HSBC estimates

Our PCCW valuation is outlined in the table above.

With 21% upside to the share price as of the close of business on 5 July, we upgrade from Hold to Buy.

We note that PCCW stock is increasingly trading in line with sales momentum (chart below). We expect this to continue as growth focuses on the potential for development of the Media business.

PCCW share price trades closely with sales momentum since late 2015 5.4 Price Sales momentum 5.2 6% 5.0 4% 4.8 4.6 2% 4.4 0% 4.2 4.0 -2% Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16

Source: Thomson Reuters Datastream, HSBC

Key downside risks

 Uncertainty over acquisition strategy. Part of the reason for the c25% holding company discount at which PCCW stock trades is the lack of visibility into its acquisition strategy. Thus far the company has not made a large acquisition, but it continues to look for suitable targets in both the media and solutions areas. Any such acquisition may involve a high valuation with returns that may not be significant in the near term.

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 Greater competition in wireless and wireline markets. As HKT Trust is a large part of PCCW’s value, competition affecting this entity would materially affect PCCW. PCCW seeks to use dividends from HKT to fund overseas acquisitions in both media and solutions.

 Greater competition in the media market in Hong Kong and Asia. Companies such as LeEco, Netflix, TVB, Hooq, and iflix may perform better than we expect, reducing the growth outlook for PCCW Media.

 Slowing growth in the solutions segment. The solutions segment is dependent on robust demand for corporate and IT services in Hong Kong and mainland China particularly. Slow growth in these economies may limit the growth outlook at this segment.

 Increase in financing costs. PCCW has relatively high levels of debt, at c2.6x 2016e EBITDA. Interest costs rising faster than we expect is a risk to earnings.

 New competition in free-to-air media. i-Cable has applied for an FTA licence, but may have a new owner. This might introduce new competition to the current duopoly of TVB and ViuTV. Change in forecasts

We raise our revenue forecasts and trim EBITDA due to our revised assessment of the Media business. Our revenue estimates are only in line with consensus – we believe – because of lower handset sales estimates at HKT Trust, while EBITDA is lower because of losses in the Media business.

Our forecasts vs consensus and prior estimates are outlined in the table overleaf.

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PCCW: HSBCe vs consensus, prior estimates HKDm 2015e 2016e 2017e 2018e 15-18e CAGR Consensus Revenue 39,314 42,099 43,737 45,491 5.0% Change y-o-y 18.1% 7.1% 3.9% 4.0% Operating expense (27,436) (29,410) (30,479) (31,689) 4.9% Change y-o-y 19.6% 7.2% 3.6% 4.0% EBITDA 11,878 12,689 13,259 13,802 5.1% Change y-o-y 14.9% 6.8% 4.5% 4.1% Margin 30.2% 30.1% 30.3% 30.3% Operating profit 5,818 6,335 6,580 6,606 Change y-o-y 44.1% 8.9% 3.9% 0.4% Margin 14.8% 15.0% 15.0% 14.5% Net income 2,295 2,494 2,777 3,183 11.5% Change y-o-y -30.7% 8.7% 11.3% 14.6% EPS 0.31 0.34 0.37 0.44 12.7% HSBC Revenue 39,314 42,170 44,042 45,419 4.9% Change y-o-y 18.1% 7.3% 4.4% 3.1% Operating expense (27,436) (29,823) (31,476) (32,427) Change y-o-y 19.6% 8.7% 5.5% 3.0% EBITDA 11,878 12,347 12,566 12,992 3.0% Change y-o-y 14.9% 3.9% 1.8% 3.4% Margin 30.2% 29.3% 28.5% 28.6% Operating profit 5,818 6,182 6,253 6,628 4.4% Change y-o-y 44.1% 6.3% 1.2% 6.0% Margin 14.8% 14.7% 14.2% 14.6% Net income 2,295 2,640 2,734 3,716 17.4% Change y-o-y -30.7% 15.0% 3.6% 35.9% EPS 0.31 0.36 0.37 0.51 17.4% HSBC versus consensus 2015e 2016e 2017e 2018e Sales 0.0% 0.2% 0.7% -0.2% EBITDA 0.0% -2.7% -5.2% -5.9% OP 0.0% -2.4% -5.0% 0.3% Net income 0.0% 5.8% -1.6% 16.8% EPS 2.3% 6.8% 0.0% 15.8% HSBC Feb 2016 estimates 2015e 2016e 2017e 2018e Sales 39,314 41,516 42,706 43,536 EBITDA 11,878 12,424 12,757 12,942 OP 5,818 6,260 6,456 6,606 Net income 2,295 2,706 2,904 3,698 EPS 0.31 0.37 0.40 0.50 HSBC versus previous 2015e 2016e 2017e 2018e Sales 0.0% 1.6% 3.1% 4.3% EBITDA 0.0% -0.6% -1.5% 0.4% OP 0.0% -1.3% -3.1% 0.3% Net income 0.0% -2.4% -5.9% 0.5% EPS 0.0% -2.4% -5.9% 0.5% Source: Company data, Bloomberg, HSBC estimates

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Financials & valuation: PCCW Buy

Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (HKDm) EV/sales 1.9 1.7 1.5 1.4 Revenue 39,314 42,274 44,265 45,729 EV/EBITDA 6.1 5.7 5.4 5.0 EBITDA 11,878 12,357 12,620 12,995 EV/IC 2.5 2.4 2.3 2.1 Depreciation & amortisation -6,060 -6,165 -6,314 -6,368 PE* 16.7 14.5 13.8 10.3 Operating profit/EBIT 5,818 6,192 6,306 6,627 PB 3.5 3.0 2.7 2.4 Net interest -1,547 -1,643 -1,602 -800 FCF yield (%) 15.8 16.1 16.4 18.6 PBT 4,440 4,997 5,152 6,274 Dividend yield (%) 4.8 4.2 4.4 5.3 HSBC PBT 4,271 4,549 4,704 5,826 *Based on HSBC EPS (diluted) Taxation -447 -651 -676 -861 Net profit 2,295 2,648 2,778 3,715 HSBC net profit 1,868 2,100 2,230 3,167 Issuer information Cash flow summary (HKDm) Share price (HKD) 5.22 Free float 72% Cash flow from operations 9,398 10,617 10,758 11,878 Target price (HKD) 6.30 Sector Diversified Telecoms Capex -3,534 -3,797 -3,976 -4,108 Reuters (Equity) 0008.HK Country Hong Kong Cash flow from investment -7,762 -6,797 -6,976 -6,908 Bloomberg (Equity) 8 HK Analyst Neale Anderson Dividends -1,481 -1,833 -1,613 -1,692 Market cap (USDm) 5,184 Contact +852 2996 6716 Change in net debt 1,091 -2,474 -2,694 -3,278

FCF equity 6,083 6,210 6,349 7,177 Balance sheet summary (HKDm) Price relative Intangible fixed assets 10,968 10,327 9,946 9,604 Tangible fixed assets 18,713 19,986 21,029 21,910 6.50 6.50 Current assets 20,139 19,709 22,565 26,063 6.00 6.00 Cash & others 7,504 6,888 9,583 12,861 5.50 5.50 Total assets 56,575 56,825 60,391 64,477 Operating liabilities 13,614 13,667 13,869 14,576 5.00 5.00 Gross debt 41,969 38,879 38,879 38,879 4.50 4.50 Net debt 34,465 31,991 29,296 26,018 4.00 4.00 Shareholders’ funds 11,024 12,613 14,280 15,951 Invested capital 28,702 29,467 30,089 30,140 3.50 3.50 3.00 3.00 2014 2015 2016 2017 PCCW Rel to HANG SENG INDEX Ratio, growth and per share analysis Year to 12/2015a 12/2016e 12/2017e 12/2018e Note: Priced at close of 5 July 2016 Y-o-y % change Source: HSBC Revenue 18.1 7.5 4.7 3.3 EBITDA 14.9 4.0 2.1 3.0 Operating profit 44.1 6.4 1.8 5.1 PBT -18.9 12.5 3.1 21.8 HSBC EPS -30.7 15.4 4.9 33.7 Ratios (%) Revenue/IC (x) 1.4 1.5 1.5 1.5 ROIC 29.1 28.2 27.2 27.1 ROE 17.6 17.8 16.6 21.0 ROA 9.5 10.2 10.0 9.8 EBITDA margin 30.2 29.2 28.5 28.4 Operating profit margin 14.8 14.6 14.2 14.5 EBITDA/net interest (x) 7.7 7.5 7.9 16.2 Net debt/equity 258.3 192.4 146.5 111.4 Net debt/EBITDA (x) 2.9 2.6 2.3 2.0 CF from operations/net debt 27.3 33.2 36.7 45.7 Per share data (HKD) EPS Rep (diluted) 0.31 0.36 0.38 0.51 HSBC EPS (diluted) 0.31 0.36 0.38 0.51 DPS 0.25 0.22 0.23 0.28 Book value 1.50 1.72 1.95 2.18

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HKT (6823 HK)

 Stable free cash flow growth expected  CSL acquisition synergies to continue through 2016e  Downgrade from Buy to Hold on adjustment of cash tax payment; trim DCF-derived target price by 5%, to HKD12.5

Investment summary

HKT is the most liquid of the Hong Kong Telcos, with trading in its stock at cUSD13m per day. Since completing its HKD18.87bn (cUSD2.43bn) acquisition of CSL from Telstra in May 2014, HKT Trust has steadily integrated the two networks. After an initial increase in prices (with HKD68 plans largely removed from the market in June 2014) a second round of re-pricing was driven by the popular iPhone 6 and 6 Plus launch at the end of 2014. We see three potential positives:

 Wireless re-pricing benefits, driven by strong network. Over time, we expect HKT’s position as the strongest wireless network in Hong Kong (due to fast fibre backhaul, largest Wi-Fi network, and largest spectrum holding) to result in steady growth in high-value subscribers.  Synergy benefits from the CSL acquisition. We also see benefits from the reduction in costs as the CSL business is fully integrated. Management guided for total synergies equivalent to c10% of the costs of the combined operation. We note that HKT has a strong track record in cost efficiency. As an example, the August 2015 launch of Tap’n’Go wireless payment was developed within the standard operating expense budget.

 Wireline revenue growth. HKT has proven adept at selling value-added services (such as its ‘Eye’ interactive terminal) that have kept voice revenue stable. In broadband, it has the largest coverage (as the ex-incumbent) and should continue to benefit as customers in remoter parts of Hong Kong upgrade to high-speed – despite increasing price competition in the high density urban areas.

However, at mid-2016 we see increased competition in the wireless and residential consumer businesses, which is likely to weigh on growth. We believe HKT’s business should remain stable, but see growth as more challenging in this environment.

We raise our tax estimate which we now believe was too low, reducing our DCF valuation by 5%. We expect continued benefits from mobile cost reductions, but limited re-pricing benefits in either mobile or residential broadband.

Valuation and rating

We use a DCF valuation methodology to value HKT. Given HKT’s status as a business trust paying out 100% of adjusted funds flow, its ability to generate cash sustainably is a principal driver of value. The key components of our WACC are a risk-free rate of 3.5%, a beta of 0.6 and an equity risk premium of 6%, resulting in a cost of equity of 7.3%. We apply a cost of debt of

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4% and a debt-to-capital ratio of 30% and a terminal growth rate range of 1%, reflecting a stable growth outlook for the wireless and broadband market, resulting in a WACC of 6.1%.

Our adjusted funds flow (AFF) forecast is outlined below.

With 11% upside to our target price as of close of business on 5 July 2016, we downgrade from Buy to Hold. We apply a Hold rating as we believe that the outlook for price increases in mobile and residential broadband will remain muted in the near term.

Risks to our view

Downside risks to our view are outlined below:  Management change. The HKT management team has a proven track record and strong reputation. The departure of any of the senior executives could affect this and thus the company’s ability to execute.  Higher capex as network rollout reaches rural areas. By mid-2015, HKT’s broadband network had reached most of urban Hong Kong. With only rural, hard-to-reach areas not yet covered, there is a risk of capex increasing as the company expands its network.  Decline in local and international telephony revenue. Thus far, HKT has defied the inexorable decline in basic telephony revenue posted by most other Asian incumbents, due to expansion into new business areas and astute combinations with new products (such as the PCCW ‘Eye’). Declines in these businesses would be a drag on overall group revenue.

HKT Adjusted Funds Flow (AFF) forecast, HKDm, USDm Jun-15 Dec-15 Jun-16 Dec-16 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Adjusted Funds Flow (AFF), HKDm EBITDA 5,770 6,330 6,138 6,480 7,669 7,901 10,242 12,100 12,618 12,861 Change y-o-y 30.4% 8.8% 6.4% 2.4% 3.5% 3.0% 29.6% 18.1% 4.3% 1.9% Margin 36.1% 33.8% 35.3% 33.8% 36.4% 34.6% 35.5% 34.8% 34.5% 34.4% Less cash outflows in respect of: – – – – – – CACs + License fees (1,519) (1,808) (1,500) (1,800) (1,719) (1,603) (2,802) (3,327) (3,300) (3,100) % of capitalized CAC & licence 33.1% 39.0% 32.4% 38.3% 87.1% 61.0% 40.6% 36.1% 35.4% 32.8% fee of service revenue Capex (1,304) (1,733) (1,480) (1,696) (1,906) (1,980) (2,510) (3,037) (3,177) (3,321) Change y-o-y 14.9% 26.0% 13.5% -2.1% 21.5% 3.9% 26.8% 21.0% 4.6% 4.5% % of sales 8.2% 9.2% 8.5% 8.8% 9.0% 8.7% 8.7% 8.7% 8.7% 8.9% AFF before tax paid,finance 2,947 2,789 3,158 2,983 4,044 4,318 4,930 5,736 6,141 6,440 costs and NWC Change y-o-y 16.9% 15.7% 7.2% 7.0% -8.7% 6.8% 14.2% 16.3% 7.1% 4.9% Adjustments – – – – – – Tax payment (75) (290) (225) (450) (203) (331) (395) (365) (675) (675) Net Finance costs paid (435) (467) (474) (463) (728) (689) (801) (902) (937) (1,041) Working cap chg (484) 108 (450) 100 (441) (397) (380) (376) (350) (250) AFF ( HKDm) 1,953 2,140 2,009 2,170 2,672 2,901 3,354 4,093 4,179 4,474 Change y-o-y 22.8% 21.3% 2.9% 1.4% 11.9% 8.6% 15.6% 22.0% 2.1% 7.1% AFF per Share Stapled Unit, HKD 0.26 0.28 0.27 0.29 0.42 0.43 0.47 0.54 0.55 0.59

Adjusted Funds Flow (AFF), USDm EBITDA 739 813 789 833 984 1,013 1,313 1,552 1,621 1,653 Less cash outflows in respect of: – – – – – – CACs + License fees (194) (232) (193) (231) (221) (206) (359) (427) (424) (398) Capex (167) (223) (190) (218) (245) (254) (322) (390) (408) (427) AFF before tax paid,finance 377 358 406 383 519 554 632 736 789 828 costs and NWC Adjustments – – – – – – Tax payment (10) (37) (29) (58) (26) (42) (51) (47) (87) (87) Net Finance costs paid (56) (60) (61) (60) (93) (88) (103) (116) (120) (134) Working cap chg (62) 14 (58) 13 (57) (51) (49) (48) (45) (32) AFF (USDm) 250 275 258 279 343 372 430 525 537 575 Source: Company data, HSBC estimates

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 Higher churn than we currently forecast. Higher-than-expected wireless competition leading to slower migration from flat-rate data plans to tiered data plans, as well as higher churn.  Competition in the consumer broadband market. Higher-than-expected competition in broadband business may lead to higher than expected broadband churn, and lower broadband ARPU. Particularly, we highlight that HKBN has shifted focus to subscriber growth rather than ARPU growth to achieve its 10% annual revenue growth target. This may result in greater price competition for HKT, leading to lower ARPU.

 Increased competition in the wireless market from China Mobile. Thus far, China Mobile (941 HK – 88.60 – Hold – TP HKD90) has been relatively passive in Hong Kong. If it changed this approach its size could result in disruption in the market.

Upside risks to our view are the opposite of those above.

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Forecasts versus previous

We reduce our net income and EPS estimates slightly due to higher tax forecasts. We now assume USD87m in cash taxes payable in 2016. This compares to our prior forecast for USD47m. Otherwise our forecasts are substantially unchanged.

HKT: HSBCe vs consensus, prior forecasts HKDm 2015e 2016e 2017e 2018e 15-18e CAGR Consensus Revenue 34,729 35,883 36,844 38,238 3.3% Change y-o-y 20.5% 3.3% 2.7% 3.8% Operating expense (34,729) (30,571) (31,242) (32,517) -2.2% Change y-o-y 21.8% -12.0% 2.2% 4.1% EBITDA 12,100 5,312 5,602 5,721 -22.1% Change y-o-y 18.1% -56.1% 5.5% 2.1% Margin 34.8% 14.8% 15.2% 15.0% Operating profit 6,024 6,628 6,925 6,880 4.5% Change y-o-y 35.4% 10.0% 4.5% -0.7% Margin 17.3% 18.5% 18.8% 18.0% Net income 3,949 4,395 4,578 4,699 6.0% Change y-o-y 32.0% 11.3% 4.2% 2.7% EPS 0.52 0.59 0.61 0.63 6.6% HSBC Revenue 34,729 36,573 37,419 38,026 3.1% Change y-o-y 20.5% 5.3% 2.3% 1.6% Operating expense (22,629) (23,955) (24,558) (25,086) Change y-o-y 21.8% 5.9% 2.5% 2.2% EBITDA 12,100 12,618 12,861 12,940 2.3% Change y-o-y 18.1% 4.3% 1.9% 0.6% Margin 34.8% 34.5% 34.4% 34.0% Operating profit 5,898 6,607 6,630 6,563 3.6% Change y-o-y 35.4% 12.0% 0.3% -1.0% Margin 17.0% 18.1% 17.7% 17.3% Net income 3,949 4,496 4,461 4,342 3.2% Change y-o-y 32.0% 13.8% -0.8% -2.7% EPS 0.52 0.59 0.59 0.57 3.2% HSBC versus consensus 2015e 2016e 2017e 2018e Sales 0.0% 1.9% 1.6% -0.6% EBITDA 0.0% 137.5% 129.6% 126.2% OP -2.1% -0.3% -4.3% -4.6% Net income 0.0% 2.3% -2.5% -7.6% EPS 0.0% 1.4% -3.8% -9.3% HSBC Feb 2016 estimates 2015e 2016e 2017e 2018e Sales 34,729 36,573 37,419 38,026 EBITDA 12,100 12,618 12,861 12,940 OP 5,898 6,607 6,630 6,563 Net income 3,949 4,496 4,454 4,325 EPS 0.52 0.59 0.59 0.57 HSBC versus previous 2015e 2016e 2017e 2018e Sales 0.0% 0.0% 0.0% 0.0% EBITDA 0.0% 0.0% 0.0% 0.0% OP 0.0% 0.0% 0.0% 0.0% Net income 0.0% 0.0% 0.2% 0.4% EPS 0.0% 0.0% 0.2% 0.4% Source: Company data, Bloomberg, HSBC estimates

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Financials & valuation: HKT Trust Hold

Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (HKDm) EV/sales 3.4 3.3 3.2 3.2 Revenue 34,729 36,573 37,419 38,026 EV/EBITDA 9.7 9.5 9.4 9.3 EBITDA 12,100 12,618 12,861 12,940 EV/IC 5.0 4.5 4.5 4.5 Depreciation & amortisation -6,202 -6,011 -6,232 -6,377 PE* 21.6 19.0 19.2 19.7 Operating profit/EBIT 5,898 6,607 6,630 6,563 PB 2.3 2.3 2.3 2.3 Net interest -1,310 -1,331 -1,395 -1,434 FCF yield (%) 8.1 6.1 8.6 8.7 PBT 4,586 5,336 5,295 5,159 Dividend yield (%) 4.8 4.9 5.2 5.6 HSBC PBT 4,588 5,276 5,235 5,129 *Based on HSBC EPS (diluted) Taxation -600 -801 -794 -776 Net profit 3,949 4,496 4,461 4,342 HSBC net profit 3,794 4,366 4,331 4,242 Issuer information Cash flow summary (HKDm) Share price (HKD) 11.30 Free float 72% Cash flow from operations 10,345 10,656 10,740 10,765 Target price (HKD) 12.50 Sector Diversified Telecoms Capex -3,054 -5,150 -3,341 -3,300 Reuters (Equity) 6823.HK Country Hong Kong Cash flow from investment -6,409 -8,750 -6,941 -6,700 Bloomberg (Equity) 6823 HK Analyst Neale Anderson Dividends -3,140 -4,089 -4,176 -4,471 Market cap (USDm) 11,027 Contact +852 2996 6716 Change in net debt -266 2,378 539 405

FCF equity 6,905 5,229 7,328 7,440 Balance sheet summary (HKDm) Price relative Intangible fixed assets 9,314 10,809 10,362 9,726 Tangible fixed assets 16,674 17,919 19,075 20,034 Current assets 12,347 10,644 10,710 10,801 14.40 14.40 Cash & others 3,768 2,000 2,000 2,000 13.40 13.40 Total assets 40,100 41,126 41,892 42,301 12.40 12.40 Operating liabilities 10,899 10,956 11,152 11,510 11.40 11.40 Gross debt 36,315 36,925 37,464 37,869 10.40 10.40 Net debt 32,547 34,925 35,464 35,869 9.40 9.40 Shareholders’ funds 37,616 37,936 37,926 37,524 8.40 8.40 Invested capital 23,668 26,416 26,995 27,051 7.40 7.40 6.40 6.40 2014 2015 2016 2017 HKT Trust Rel to HANG SENG INDEX Ratio, growth and per share analysis Year to 12/2015a 12/2016e 12/2017e 12/2018e Note: Priced at close of 5 July 2016 Y-o-y % change Source: HSBC Revenue 20.5 5.3 2.3 1.6 EBITDA 18.1 4.3 1.9 0.6 Operating profit 35.4 12.0 0.3 -1.0 PBT 39.0 16.4 -0.8 -2.6 HSBC EPS 23.7 13.8 -0.8 -2.7 Ratios (%) Revenue/IC (x) 1.5 1.5 1.4 1.4 ROIC 36.0 35.6 33.4 32.8 ROE 10.0 11.6 11.4 11.2 ROA 12.7 13.9 13.7 13.3 EBITDA margin 34.8 34.5 34.4 34.0 Operating profit margin 17.0 18.1 17.7 17.3 EBITDA/net interest (x) 9.2 9.5 9.2 9.0 Net debt/equity 86.3 91.7 93.0 95.0 Net debt/EBITDA (x) 2.7 2.8 2.8 2.8 CF from operations/net debt 31.8 30.5 30.3 30.0 Per share data (HKD) EPS Rep (diluted) 0.52 0.59 0.59 0.57 HSBC EPS (diluted) 0.52 0.59 0.59 0.57 DPS 0.54 0.55 0.59 0.63 Book value 4.97 5.02 5.01 4.96

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Appendix

 We compare Asian OTT business models  Viu looks to be well placed and focused on a different business than iflix and Hooq  Limited visibility on Hooq suggests the service is at an early stage

OTT TV in ASEAN Viu iflix Hooq Subscribers (m) 10 (Mar-16) 2 (Feb-16) >0.1* (Mar-16) Valuation (USDm) 566 450 N/A Shareholders PCCW Catcha Group, Evolution Media Singtel, Sony, WB Capital, PLDT, Sky, MGM, Emtek Group, TPG, Capricorn Investment, Jungle Ventures and other celebrity investors Business model both freemium and premium, subscription-based and advertising-based Country coverage HK Y N N SG Y N Y IN Y N Y ID Y Y Y MY Y Y N TH Y Y Y PH N Y Y Vietnam N Planned N UAE Y Planned N Kuwait Y N N Nigeria Y N N Kenya Y N N Oman Y N N Egypt Y N N *Paying subscribers in the Philippines Source: Company data, HSBC estimates

Netflix

Netflix was founded in 1997 by Marc Randolph and Reed Hastings. It started as a DVD-by-mail service in 1998 and began streaming in 2007. It is a global provider of streaming films and television series with presence in more than 190 countries (except China) with customers enjoying more than 125 million hours of TV shows and movies per day. Of these, Netflix differentiates itself by offering original series (i.e. House of Cards), documentaries and feature films. Members can watch as much as they want, anytime, anywhere, on nearly any Internet-connected screen.

Netflix currently has more than 81m members (42% international members) in 1Q16, growing 31% y-o-y and of which 95% are paying subscribers.

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Netflix does not offer pay-per-view or free ad-supported content but is all about flat-fee unlimited viewing commercial-free (i.e. pure subscription-based model).

Netflix grew its revenue by 23%, to USD6.8bn, during 2015, with an EBIT margin of 5% and a net margin of 2%. Netflix is now valued at USD40bn and is trading at a price-to-sales ratio of 5.2x.

Hulu

Hulu was launched in 2008 as a joint-venture of The Walt Disney (32%), 21st Century Fox (36%) and Comcast (32%). It is a premium streaming TV destination that offers hundreds of thousands of hours of current season programming, premium original content, films and full seasons of hit series. It is the only streaming subscription service that offers current season from 5 of the 6 largest US broadcast networks, as well as acclaimed Hulu Originals (e.g. The Mindy Project, The Path, 11.22.63, Difficult People, etc.). In contrast to Netflix, Hulu supplements cable TV instead of trying to replace it, and distributes videos from major networks aside from NBC, ABC and Fox.

Hulu currently has 12m subscribers, partners with 400 content providers, over 700m hours of content streamed and has 2000+ advertising partners.

Unlike Netflix, Hulu offers partially ad-supported streaming services and charges subscribers with limited commercials for USD7.99/month or commercial-free for USD11.99/month (i.e. both advertising-based and subscription-based models).

It is reported Hulu’s revenue in 2015 was roughly USD1.6bn (of which subscription-advertising split is half-half), growing at a 22% CAGR in 2013-15. (http://www.statista.com/statistics/258004/hulus-annual-revenue/) Yahoo reported in May 2016 that Hulu could be worth USD15-25bn. (https://www.yahoo.com/movies/hulu-now-worth-25- billion-15-billion-analyst-102109555.html)

iflix

iflix is founded in 2014 by Patrick Grove (CEO of Catcha Group), Mark Britt and Evolution Media Capital. It is the Southeast Asia’s leading internet TV service provider and is a SVOD (subscription video-on-demand) platform based in Kuala Lumpur, Malaysia. iflix’s services cater specifically to the demands of SE Asian consumers as it offers subscribers unlimited access to thousands of hours of entertainment for a low monthly price. It differentiates itself by offering local content and local subtitles. The company recently announced a succession of landmark content deals with Hollywood and international studios (e.g. Warner Bros, BBC Worldwide, Fox). iflix established its presence in Malaysia, Thailand and the Philippines in 2015 and will be expanding into Indonesia, Vietnam and Sri Lanka in 2016.

iflix grew its subscriber numbers extremely rapidly from 1m in Dec 2015 to hitting 2m in Feb 2016 (of which more than half comes from the Philippines market). Patrick Grove has a vision of aiming at 10m customers within a decade.

In April 2015, iflix completed a USD30m funding led by Catcha Group and PLDT of which the later converted its USD15m investment from convertible notes into ordinary shares in March 2016 and now accounts for 7.5% equity stake, which values iflix at USD450m currently.

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Hooq

Hooq was launched in January 2015 by Singtel, Sony and Warner Bros. Hooq delivers both Hollywood blockbusters and TV series as well as popular local movies and programmes to customers anytime, anywhere by enabling them to stream and download on their device or platform of choice. It positions itself as a gateway to a world of unlimited entertainment and gives subscribers unlimited access to over 10,000 movies and TV series currently. Through its app, Hooq streams 35,000 hours of movies and TV series which it claims to be the largest content library in Asia. A key differentiator of Hooq is it will use the Singtel Group’s billing capabilities which is a crucial enabler in developing markets where credit card ownership is still limited. Currently the Singtel Group provides market access with its customer base of over half a billion mobile subscribers.

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Notes

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Notes

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Notes

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Disclosure appendix

Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Neale Anderson and Aric Hui

Important disclosures Equities: Stock ratings and basis for financial analysis HSBC believes an investor’s decision to buy or sell a stock should depend on individual circumstances such as the investor’s existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts’ views and the basis for the rating.

From 23rd March 2015 HSBC has assigned ratings on the following basis: The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce.

Our ratings are re-calibrated against these bands at the time of any ‘material change’ (initiation or resumption of coverage, change in target price or estimates).

Upside/Downside is the percentage difference between the target price and the share price.

Prior to this date, HSBC’s rating structure was applied on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.

*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month’s average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock’s status to change.

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Rating distribution for long-term investment opportunities As of 6 July 2016, the distribution of all independent ratings published by HSBC is as follows: Buy 45% (25% of these provided with Investment Banking Services) Hold 40% (25% of these provided with Investment Banking Services) Sell 15% (21% of these provided with Investment Banking Services)

For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above.

For the distribution of non-independent ratings published by HSBC, please see the disclosure page available at http://www.hsbcnet.com/gbm/financial-regulation/investment-recommendations-disclosures.

Share price and rating changes for long-term investment opportunities PCCW (0008.HK) share price performance HKD vs HSBC Rating & target price history rating history From To Date Analyst 6 Neutral Overweight 29 Jan 2014 Tucker Grinnan 5.5 Overweight Restricted 13 Jun 2014 5 Restricted Neutral 25 Sep 2014 Tucker Grinnan 4.5 Neutral Hold 30 Apr 2015 Neale Anderson Hold Buy 1 Oct 2015 Neale Anderson 4 Buy Hold 7 Jan 2016 Neale Anderson 3.5 3 Target price Value Date Analyst 2.5 Price 1 3.60 27 Sep 2013 Tucker Grinnan 2 Price 2 4.00 29 Jan 2014 Tucker Grinnan 1.5 Price 3 4.35 16 Mar 2014 Tucker Grinnan 1 Price 4 4.70 13 Apr 2014 Tucker Grinnan Price 5 4.72 22 Apr 2014 Tucker Grinnan

Price 6 Restricted 13 Jun 2014

Jul-11 Jul-15 Jul-13 Jul-14 Jul-16 Jul-12 Price 7 5.10 25 Sep 2014 Tucker Grinnan Price 8 5.44 19 Nov 2014 Neale Anderson Source: HSBC Price 9 5.60 19 Jan 2015 Neale Anderson Price 10 5.70 4 Feb 2015 Neale Anderson Price 11 5.30 15 Feb 2015 Neale Anderson Price 12 5.10 6 Aug 2015 Neale Anderson Price 13 5.40 7 Jan 2016 Neale Anderson Price 14 5.00 8 Jan 2016 Neale Anderson Price 15 5.20 28 Feb 2016 Neale Anderson Source: HSBC HKT Trust (6823.HK) share price performance HKD vs Rating & target price history HSBC rating history From To Date Analyst 14 Overweight Neutral 29 Jan 2014 Tucker Grinnan 13 Neutral Restricted 13 Jun 2014 12 Restricted Neutral 25 Sep 2014 Tucker Grinnan 11 Neutral Overweight 19 Nov 2014 Neale Anderson Overweight Buy 30 Apr 2015 Neale Anderson 10 9 Target price Value Date Analyst 8 Price 1 7.75 11 Oct 2013 Tucker Grinnan 7 Price 2 Restricted 13 Jun 2014 6 Price 3 10.00 25 Sep 2014 Tucker Grinnan 5 Price 4 12.00 19 Nov 2014 Neale Anderson 4 Price 5 13.00 4 Feb 2015 Neale Anderson Price 6 12.40 5 Aug 2015 Neale Anderson

Price 7 13.20 25 Feb 2016 Neale Anderson

Jul-11 Jul-15 Jul-12 Jul-13 Jul-14 Jul-16 Source: HSBC

Source: HSBC

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To view a list of all the independent fundamental ratings disseminated by HSBC during the preceding 12-month period, please see the disclosure page available at www.research.hsbc.com/A/Disclosures.

HSBC & Analyst disclosures Disclosure checklist

Company Ticker Recent price Price date Disclosure PCCW 0008.HK 5.22 5-Jul-2016 2, 4, 6, 7 Source: HSBC

1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 31 May 2016 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 May 2016, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 31 May 2016, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 31 May 2016, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company 12 As of 01 July 2016, HSBC beneficially held a net long position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. 13 As of 01 July 2016, HSBC beneficially held a net short position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology.

HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt (including derivatives) of companies covered in HSBC Research on a principal or agency basis.

Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking, sales & trading, and principal trading revenue.

Whether, or in what time frame, an update of this analysis will be published is not determined in advance.

Economic sanctions imposed by the EU and OFAC prohibit transacting or dealing in new debt or equity of Russian SSI entities. This report does not constitute advice in relation to any securities issued by Russian SSI entities on or after July 16 2014 and as such, this report should not be construed as an inducement to transact in any sanctioned securities.

For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. In order to find out more about the proprietary models used to produce this report, please contact the authoring analyst.

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Additional disclosures 1 This report is dated as at 6 July 2016.

2 All market data included in this report are dated as at close 5 July 2016, unless a different date and/or a specific time of day is indicated in the report.

3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC’s analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC’s Investment Banking business. Information Barrier procedures are in place between the Investment Banking, Principal Trading, and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.

4 You are not permitted to use, for reference, any data in this document for the purpose of (i) determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments, (ii) determining the price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument, and/or (iii) measuring the performance of a financial instrument.

Production and distribution disclosures 1 This report was produced and signed off by the author on 06 Jul 2016 05:03 GMT.

2 In order to see when this report was first disseminated please see the disclosure page available at https://www.research.hsbc.com/R/34/nZXVPqj

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Disclaimer

Legal entities as at 1 July 2016 Issuer of report ‘UAE’ HSBC Bank Middle East Limited, Dubai; ‘HK’ The Hongkong and Shanghai Banking Corporation Limited, Hong The Hongkong and Shanghai Banking Corporation Kong; ‘TW’ HSBC Securities (Taiwan) Corporation Limited; ‘CA’ HSBC Bank Canada, Toronto; HSBC Bank, Paris Branch; Limited HSBC France; ‘DE’ HSBC Trinkaus & Burkhardt AG, Düsseldorf; 000 HSBC Bank (RR), Moscow; ‘IN’ HSBC Securities and Level 19, 1 Queen’s Road Central Capital Markets (India) Private Limited, Mumbai; ‘JP’ HSBC Securities (Japan) Limited, Tokyo; ‘EG’ HSBC Securities Egypt Hong Kong SAR SAE, Cairo; ‘CN’ HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Telephone: +852 2843 9111 Banking Corporation Limited, Singapore Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Fax: +852 2596 0200 Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Securities (South Website: www.research.hsbc.com Africa) (Pty) Ltd, Johannesburg; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv; ‘US’ HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler AS, Istanbul; HSBC México, SA, Institución de Banca Múltiple, Grupo Financiero HSBC; HSBC Bank Australia Limited; HSBC Bank Argentina SA; HSBC Saudi Arabia Limited; The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR; The Hongkong and Shanghai Banking Corporation Limited, Bangkok Branch This document has been issued by The Hongkong and Shanghai Banking Corporation Limited (“HSBC”) in the conduct of its Hong Kong regulated business for the information of its institutional and professional investor (as defined by Securities and Future Ordinance (Chapter 571)) customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited is regulated by the Hong Kong Monetary Authority. All enquires by recipients in Hong Kong must be directed to your HSBC contact in Hong Kong. If it is received by a customer of an affiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. HSBC has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; HSBC makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of the Research Division of HSBC only and are subject to change without notice. From time to time research analysts conduct site visits of covered issuers. HSBC policies prohibit research analysts from accepting payment or reimbursement for travel expenses from the issuer for such visits. HSBC and its affiliates and/or their officers, directors and employees may have positions in any securities mentioned in this document (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). HSBC and its affiliates may act as market maker or have assumed an underwriting commitment in the securities of companies discussed in this document (or in related investments), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those companies. HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the United States and not with its non-US foreign affiliate, the issuer of this report. In the UK this report may only be distributed to persons of a kind described in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005. The protections afforded by the UK regulatory regime are available only to those dealing with a representative of HSBC Bank plc in the UK. In Singapore, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch for the general information of institutional investors or other persons specified in Sections 274 and 304 of the Securities and Futures Act (Chapter 289) (“SFA”) and accredited investors and other persons in accordance with the conditions specified in Sections 275 and 305 of the SFA. 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These respective entities make no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. This publication is distributed in New Zealand by The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR. In Japan, this publication has been distributed by HSBC Securities (Japan) Limited. It may not be further distributed in whole or in part for any purpose. In Korea, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch (“HBAP SLS”) for the general information of professional investors specified in Article 9 of the Financial Investment Services and Capital Markets Act (“FSCMA”). 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Global Telecoms, Media & Technology Research Team

Asia Associate Global Alice Cai +852 2996 6584 Analyst, Global Sector Head Analyst [email protected] Stephen Howard +44 20 7991 6820 Yogesh Aggarwal +91 22 2268 1246 [email protected] [email protected] Associate Aric Hui +852 2822 3165 Analyst [email protected] Europe Vivek Gedda +91 22 6164 0693 Analyst [email protected] Associate Nicolas Cote-Colisson +44 20 7991 6826 Qin Wang +852 2822 4393 [email protected] Analyst [email protected] Vikas Ahuja +91 22 3396 0690 Analyst [email protected] Associate Antonin Baudry +33 1 56 52 43 25 Wayne Wang +852 2914 9935 [email protected] Analyst [email protected] Neale Anderson +852 2996 6716 Analyst [email protected] Associate Christopher Johnen +49 211 910 2852 Kenneth Shim +822 3706 8779 [email protected] Analyst [email protected] Angela Tay +65 6658 0612 Analyst [email protected] Associate Dominik Klarmann, CFA +49 211 910 2769 David Huang +886 2 66312865 [email protected] Analyst [email protected] Joyce Chen +8862 6631 2862 [email protected] Analyst Sebastian Grabert +49 211 910 1096 [email protected] Analyst Jenny Lai +8862 6631 2860 Specialist Sales Analyst [email protected] Gareth Hollis +44 20 7991 5124 Luigi Minerva +44 20 7991 6928 [email protected] [email protected] Analyst Carrie Liu +8862 6631 2864 Tarun Viswanathan +44 20 7991 7843 Analyst [email protected] [email protected] Olivier Moral +33 1 5652 4322 [email protected] Analyst Kubilay Yalcin +49 211 9104880 Steven C Pelayo +852 2822 4391 [email protected] Analyst [email protected] Adam Fox-Rumley +44 20 7991 6819 Myles McMahon +852 2822 4676 [email protected] Analyst [email protected] Ricky Seo +822 37068777 Analyst [email protected] Dhiraj Saraf, CFA +91 80 3001 3773 [email protected] Analyst Rajiv Sharma +91 22 2268 1239 [email protected] Americas Analyst Analyst Christopher A Recouso +1 212 525 2279 Jerry Tsai +8862 6631 2863 [email protected] [email protected]

Analyst Analyst Ronny Berger 44 20 7991 2750 Chi Tsang +852 2822 2590 [email protected] [email protected]

Analyst Analyst Sunil Rajgopal +1 212 525 0267 Terry Chen +852 2996 6635 [email protected] [email protected]

Global Emerging Markets (GEMs) Analyst Yolanda Wang +8862 6631 2867 Analyst [email protected] Hervé Drouet +44 20 7991 6827 [email protected] Analyst Jena Han +822 3706 8772 Emerging Europe, Middle East & Africa (EMEA) [email protected] Analyst Analyst Levent Bayar +90 212 376 46 17 Will Cho +822 3706 8765 [email protected] [email protected]

Analyst Analyst Eric Chang +971 4 423 6554 John Liu +852 2822 4392 [email protected] [email protected]