Advantech Co., Ltd. (2395.TW / 2395 TT) Rating OUTPERFORM Price (10-Mar-17, NT$) 254.00 COMMENT Target Price (NT$) (From 305.00) 300.00 Upside/Downside (%) 18.1

13 March 2017 Asia Pacific/Taiwan Equity Research Imaging Technology

Advantech Co., Ltd. (2395.TW / 2395 TT) Rating OUTPERFORM Price (10-Mar-17, NT$) 254.00 COMMENT Target price (NT$) (from 305.00) 300.00 Upside/downside (%) 18.1

Mkt cap (NT$/US$ mn) 160,801 / 5,171 Phase 2 IoT transformation takes shape Enterprise value (NT$ mn) 156,579 Number of shares (mn) 633.07 ■ Improving sector outlook. We believe the industry's outlook is becoming Free float (%) 46.7 more promising with the standardisation of industrial frameworks, sensor 52-wk price range (NT$) 288-218 ADTO-6M (US$ mn) 5.2 platforms (i.e., M2.com) and network/connectivity (i.e., LoRa alliance). We Target price is for 12 months. believe these standards accelerate industrial automation adoption, smart city

Research Analysts solutions (i.e., smart medical and intelligent retail) and edge computing. Thompson Wu Industry standard standardisation drives scalability and sales growth, but will 886 2 2715 6386 [email protected] not drive commoditisation and eroding margins, as seen with consumer IoT, in Harvie Chou our view. Advantech investments and re-org directly positions for this growth. 886 2 2715 6364 [email protected] ■ Phase 2 IoT transformation takes shape. Advantech enters phase 2 of its IoT strategy, which focuses on solution ready platforms (SRP), edge intelligence servers (i.e., B+B SmartWorx), and IoT software (i.e., WISE-PaaS). The new product groups (i.e., Embedded, Industrial and Service IoT, and Allied DMS) align with technology. Industrial IoT will lead growth with recovery in Service and Embedded IoT. The US market will start to improve; Greater China and Japan remain stories. The full report covers this transformation presented at the Smart City Summit and Expo by Advantech's management. ■ Trim 2017E EPS by 1%. NT/US dollar appreciation and DRAM/SoC constraints are a headwind to 1H sales. We believe a share price pullback is an attractive entry-point as growth will start to recover in 2H and accelerate in 2018. Operating margins upside may surprise positively driven by Industrial IoT and opex-leverage. We forecast sales and net profit of NT$45.8/6.6 bn (+9%/+16% YoY) vs Consensus of NT$46.4/6.5 bn. ■ Reiterate OUTPERFORM. We believe earnings growth will accelerate to a 15% CAGR in the next three years, driven by a successful business. We argue a valuation re-rating to a historical 29x P/E, which drives our new NT$300 TP (from NT$305). Cash yield is 2.5% based on the NT$6.30 per share announced last week.

Share price performance Financial and valuation metrics

Year 12/16A 12/17E 12/18E Revenue (NT$ mn) 42,002.2 45,769.5 51,061.5 EBITDA (NT$ mn) 7,451.6 8,442.2 9,683.4 EBIT (NT$ mn) 6,631.5 7,639.6 8,861.0 Net profit (NT$ mn) 5,666.9 6,558.3 7,354.4 EPS (CS adj.) (NT$) 8.95 10.36 11.62 Change from previous EPS (%) n.a. (1.1) (1.6) Consensus EPS (NT$) n.a. 10.21 11.87 EPS growth (%) 10.8 15.7 12.1 The price relative chart measures performance against the P/E (x) 28.4 24.5 21.9 TAIWAN SE WEIGHTED INDEX which closed at 9,627.89 Dividend yield (%) 2.5 2.9 3.2 on 10/03/17. On 10/03/17 the spot exchange rate was EV/EBITDA (x) 21.0 18.5 16.0 NT$31.1/US$1 P/B (x) 6.33 5.75 5.23

Performance 1M 3M 12M ROE (%) 23.2 24.6 25.1 Absolute (%) -3.4 -1.9 8.1 Net debt/equity (%) Net Cash Net Cash Net Cash

Relative (%) -4.3 -4.4 -3.1 Source: Company data, Thomson Reuters, Credit Suisse estimates

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

13 March 2017

Advantech Co., Ltd. (2395.TW / 2395 TT) Price (10 Mar 2017): NT$254.00; Rating: OUTPERFORM; Target Price: (from NT$305.00) NT$300.00; Analyst: Thompson Wu Earnings Drivers 12/16A 12/17E 12/18E Per share 12/16A 12/17E 12/18E Embedded IoT revenues (US mn) 334.6 355.0 390.0 Shares (wtd avg.) (mn) 633 633 633 Allied DMS revenues (US mn) 429.6 465.0 511.0 EPS (Credit Suisse) (NT$) 8.95 10.36 11.62 Industrial IoT revenues (US mn) 422.0 515.0 600.0 DPS (NT$) 6.30 7.25 8.14 Service IoT (US mn) 84.20 93.00 96.00 BVPS (NT$) 40.10 44.16 48.54 - - - Operating CFPS (NT$) 12.66 8.76 12.01 Income Statement (NT$ mn) 12/16A 12/17E 12/18E Valuation (x) 12/16A 12/17E 12/18E Sales revenue 42,002 45,770 51,062 P/E 28.4 24.5 21.9 Cost of goods sold 24,885 26,993 29,844 P/B 6.33 5.75 5.23 SG & A 6,837 7,287 8,068 Dividend yield (%) 2.5 2.9 3.2 Other operating exp./(inc.) 2,829 3,047 3,467 P/CF 20.1 29.0 21.2 EBITDA 7,452 8,442 9,683 EV/sales 3.7 3.4 3.0 Depreciation & amortisation 820 803 822 EV/EBITDA 21.0 18.5 16.0 EBIT 6,631 7,640 8,861 EV/EBIT 23.6 20.5 17.4 Net interest expense/(inc.) (10) (13) (18) Earnings 12/16A 12/17E 12/18E Non-operating inc./(exp.) 456 525 290 Growth (%) Associates/JV 0 0 0 Sales revenue 10.5 9.0 11.6 Recurring PBT 7,097 8,178 9,169 EBIT 11.9 15.2 16.0 Exceptionals/extraordinaries 0 0 0 Net profit 11.0 15.7 12.1 Taxes 1,408 1,595 1,789 EPS 10.8 15.7 12.1 Profit after tax 5,689 6,583 7,379 Margins (%) Other after tax income 0 0 0 EBITDA 17.7 18.4 19.0 Minority interests 22 25 25 EBIT 15.8 16.7 17.4 Preferred dividends 0 0 0 Pre-tax profit 16.9 17.9 18.0 Reported net profit 5,667 6,558 7,354 Net profit 13.5 14.3 14.4 Analyst adjustments 0 0 0 ROE analysis (%) 12/16A 12/17E 12/18E Net profit (Credit Suisse) 5,667 6,558 7,354 ROE 23.2 24.6 25.1 Balance Sheet (NT$ mn) 12/16A 12/17E 12/18E ROIC 25.8 27.5 29.8 Cash & cash equivalents 4,638 4,995 6,805 Asset turnover (x) 1.1 1.1 1.2 Current receivables 7,364 8,358 8,654 Interest burden (x) 1.1 1.1 1.0 Inventories 5,597 5,893 6,515 Tax burden (x) 0.8 0.8 0.8 Other current assets 3,583 3,583 3,583 Financial leverage (x) 1.5 1.5 1.4 Current assets 21,182 22,829 25,558 Credit ratios 12/16A 12/17E 12/18E Property, plant & equip. 10,090 10,487 11,103 Investments 2,311 2,311 2,311 Net debt/equity (%) (16.4) (16.1) (20.6) Intangibles 4,163 4,163 3,925 Net debt/EBITDA (x) (0.56) (0.53) (0.65) Other non-current assets 793 793 793 Interest cover (x) n.a. n.a. n.a. Total assets 38,539 40,584 43,690 Accounts payable 4,983 4,911 5,145 12MF P/E multiple Short-term debt 484 484 484 Current provisions 0 0 0 Other current liabilities 5,968 5,516 5,617 Current liabilities 11,436 10,911 11,246 Long-term debt 0 0 0 Non-current provisions 0 0 0 Other non-current liabilities 1,716 1,716 1,716 Total liabilities 13,152 12,627 12,962 Shareholders' equity 25,387 27,957 30,728 Minority interests 0 0 0 Total liabilities & equity 38,539 40,584 43,690 Cash Flow (NT$ mn) 12/16A 12/17E 12/18E EBIT 6,631 7,640 8,861 Net interest 0 0 0 Tax paid 0 0 0 12MF P/B multiple Working capital 1,656 (1,815) (584) Other cash & non-cash items (273) (279) (677) Operating cash flow 8,015 5,546 7,600 Capex (1,402) (1,200) (1,200) Free cash flow to the firm 6,613 4,346 6,400 Disposals of fixed assets 0 0 0 Acquisitions 0 0 0 Divestments 0 0 0 Associate investments 0 0 0 Other investment/(outflows) (2,028) 0 0 Investing cash flow (3,430) (1,200) (1,200) Equity raised 0 0 0 Dividends paid (3,791) (3,988) (4,591) Net borrowings (397) 0 0 Other financing cash flow 150 0 0 Financing cash flow (4,038) (3,988) (4,591) Source: Credit Suisse, Thomson Reuters Total cash flow 546 358 1,810 Adjustments (267) 0 0 Net change in cash 279 358 1,810

Source: Company data, Credit Suisse estimates

Advantech Co., Ltd. (2395.TW / 2395 TT) 2 13 March 2017

Focus charts and tables

Figure 1: Advantech 2016-18E select financial data 4Q16 CS Est. Consen. 1Q17E 2Q17E 3Q17E 4Q17E 2016 2017E 2018E Sales $10,805 $10,802 $10,721 $10,001 $11,261 $11,970 $12,537 $42,002 $45,770 $51,062 Gross profit 4,350 4,466 4,412 4,031 4,620 4,954 5,171 17,118 18,776 21,218 Operating profit 1,737 1,733 1,740 1,351 1,884 2,105 2,300 6,631 7,640 8,861 Pre-tax profit 1,796 1,805 1,822 1,479 2,012 2,280 2,407 7,097 8,178 9,176 Net profit 1,422 1,447 1,468 1,185 1,614 1,829 1,930 5,667 6,558 7,362 GAAP EPS $2.25 $2.29 $2.34 $1.87 $2.55 $2.89 $3.05 $8.95 $10.36 $11.63 Sales YoY % 10.8% 10.8% 9.9% -0.7% 5.1% 15.0% 16.0% 10.5% 9.0% 11.6% Sales QoQ % 3.8% 3.8% 3.0% -7.4% 12.6% 6.3% 4.7% GM % 40.3% 41.3% 41.2% 40.3% 41.0% 41.4% 41.2% 40.8% 41.0% 41.6% Opex/sales 24.2% 25.3% 24.9% 26.8% 24.3% 23.8% 22.9% 25.0% 24.3% 24.2% OPM % 16.1% 16.0% 16.2% 13.5% 16.7% 17.6% 18.3% 15.8% 16.7% 17.4% Source: Company data, Credit Suisse estimates

Figure 2: Advantech enters Phase 2 of IoT strategy Figure 3: Business realignment to Phase 2

Source: Company data, Credit Suisse Source: Company data, Credit Suisse

Figure 4: Intelligent system spending by vertical Figure 5: Advantech P/E valuation

(x) 32.0 Sales US$ bn 2016 2017 2018 2019E 2016–19 30.0 CAGR (%) +2 Std dev = 27.6x Communications 604 620 627 634 1.6% 28.0 +1 Std dev = 25.9x Computing 363 367 369 375 1.0% 26.0 Consumer 306 323 355 386 8.1% Energy 32 36 39 43 10.0% 24.0 Average = 24.2x Healthcare 33 35 39 41 8.3% 22.0 Industrial 198 209 218 225 4.3% -1 Std dev = 22.5x Retail 19 19 19 19 0.1% 20.0 -2 Std dev = 20.8x Transportation 131 147 165 184 12.0% 18.0

Subtotal 1,686 1,757 1,830 1,907 4.2%

Jul-14 Jul-15 Jul-16

Jan-17 Jan-15 Jan-16

Mar-14 Mar-15 Mar-16

Nov-16 Nov-14 Nov-15

Sep-16 Sep-14 Sep-15

May-15 May-16 May-14

Source: IDC Research, Credit Suisse Source: Company data, Credit Suisse

Advantech Co., Ltd. (2395.TW / 2395 TT) 3 13 March 2017

Outlook shows fundamental improvement but with currency challenges Advantech has been investing in technology, channel and regional sales offices as it moves into Phase 2 of its Industrial IoT strategy. Advantech has rolled out its Cloud software platforms (i.e., WISE-PaaS), developed embedded wireless modules (i.e., M2.com); acquired B+B SmartWorx and expanded its capabilities in intelligent edge- networking solutions; and intelligent hospital solutions (i.e., Kostec). Advantech's completes this transformation with the realignment of product groups into Embedded IoT, Industrial IoT, Service IoT and Allied DMS. We expect these investments and reorganisation to start bearing fruit in 2017. 2017 outlook Advantech targets growth verticals including wider adoption of smart factory and smart city solutions and B+B SmartWorx secured gateway (i.e., Industrial IoT and Service IoT). Advantech is most optimistic on Greater China and Japan markets, and expects emerging markets' decline to bottom and returns to growth; the US business is showing signs of improvement entering the year. Overall, the company guided sales to increase double-digit with stable margin performance, but with caveat of currency headwinds. In addition, we believe Advantech is facing sector headwinds with DRAM/SoC constraints. We expect growth to take hold in 2H, as headwinds ease combined with gross margin improvement from better mix of the business (i.e., Industrial IoT). We expect to see operating leverage with opex/sales declining YoY after last year's higher cost base from deals and accelerated amortisation of intangibles. Earnings forecasts We adjusted our 2017/18E EPS by 1%. We raised our 2017E sales forecast to NT$45.8 bn, or 9% YoY. We assumed a US/NT exchange of NT$31.5. We have modeled sales growth below the double-digit guidance due to NT dollar appreciation vs USD. We expect Industrial IoT growth to remain the strongest amongst the four product groups with sales growth of over 22%. The recent acquisition of Kostec does not materially move earnings and will be included in the Sevice IoT product group. We expect an acquisition in 2017. We also expect gross margins to improve, driven by high-margin growth of Industrial IoT. We expect opex/sales leverage and margins to improve nearly 90 bp to 16.7%. Overall, we forecast NT$6.5 bn in net profit, nearly 16% YoY growth with EPS of NT$10.4.

Figure 6: Advantech select financial forecasts 2015 2016 2017E 2018E 2019E Sales $38,001 $42,002 $45,770 $51,062 $56,763 YoY % chg 6.3% 10.5% 9.0% 11.6% 11.2% Gross margin % 40.4% 40.8% 41.0% 41.6% 42.1% Opex/sales % 24.8% 25.0% 24.3% 24.2% 24.2% Operating margin 15.6% 15.8% 16.7% 17.4% 17.9% Net profit 5,104 5,667 6,558 7,362 8,397 YoY % chg 4.0% 11.0% 15.7% 12.2% 14.1% GAAP EPS $8.08 $8.95 $10.36 $11.63 $13.26 Cas dividend per share $6.00 $6.30 $7.25 $8.14 $9.28 Cash dividend pay-out 74% 70% 70% 70% 70%

Source: Company data, Credit Suisse estimates

Advantech Co., Ltd. (2395.TW / 2395 TT) 4 13 March 2017

Figure 7: Forecasts by product group—Industrial IoT in focus in 2017

US$ mn 2015 2016 2017E 2018E 2019E 2017E 2016-19E Segment background YoY % chg CAGR Embedded Core & IoT Modules 331 335 355 390 425 6.1% 8.3% Inustrial M/B, display, flash storage, M2.com, WISE-Paas, Cloud Allied DMS 398 430 465 511 557 8.2% 9.0% Network & embedded switches, applied computing DMS Industrial IoT 358 422 515 600 695 22.0% 18.1% I/O onctrollers, intelligente systems, network edge solutions Service IoT 91 84 93 96 100 10.5% 5.9% Intelligent medical, iRetail platforms, digital signange, logistics, smart city Advantech Global Service 23 23 25 24 25 10.6% 3.4% Maintenance and service support Total sales US$ 1,201 1,293 1,453 1,621 1,802 12.4% 11.7% US/NT$ $31.64 $32.48 $31.50 $31.50 $31.50 Source: Company data, Credit Suisse estimates Reiterate OUTPERFORM Advantech is our top pick for the industrial IoT/automation investment themes. We believe Advantech will successfully execute its Phase 2 IoT strategy and deliver US$2 bn in sales by 2020 as target. We believe earnings growth will accelerate to a 15% CAGR in the next three years driven by a successful business. We argue a valuation re-rating to a historical 29x P/E, which drives our new NT$300 TP. Cash yield is 2.5% based on the NT$6.30 per share announced last week. 2016 Results

Figure 8: 4Q16 and 2016 results vs CS/Consensus forecasts (NT$ mn) 4Q16 2016 Actual CS %Diff Consen. %Diff Actual CS %Diff Consen. %Diff Revenues $10,805 $10,802 0.0% $10,721 0.8% $42,002 $41,999 0.0% $41,957 0.1% Gross profit 4,350 4,466 -2.6% 4,412 -1.4% 17,118 17,234 -0.7% 17,179 -0.4% Operating profits 1,737 1,733 0.2% 1,740 -0.2% 6,631 6,628 0.1% 6,647 -0.2% Non-op income/exp 59 71 -17.2% 82 -28.1% 466 478 -2.6% 487 -4.4% Pre-tax income 1,796 1,805 -0.5% 1,822 -1.4% 7,097 7,106 -0.1% 7,134 -0.5% Net income 1,422 1,447 -1.7% 1,468 -3.1% 5,667 5,691 -0.4% 5,723 -1.0% GAAP EPS (NT$) $2.25 $2.29 -1.9% $2.34 -4.1% $8.95 $9.01 -0.7% $9.05 -1.1% YoY % sales change 10.8% 10.8% 9.9% 10.5% 10.5% 10.4% GM% 40.3% 41.3% 41.2% 40.8% 41.0% 40.9% OpEx/sales% 24.2% 25.3% 24.9% 25.0% 25.3% 25.1% OPM% 16.1% 16.0% 16.2% 15.8% 15.8% 15.8% NM% 13.2% 13.4% 13.7% 13.5% 13.6% 13.6%

Source: Company data, Credit Suisse estimates

4Q16 sales were NT$10.8 bn (+11%/+4% YoY/QoQ) and EPS of NT$2.25 (+5.8%/-3.3% YoY/QoQ). Gross margin was 40.3% and below our forecasts primarily due to the mix; however, better opex control delivered operating margin of 16.1%, which was about in line with our forecasts. Advantech also faced component shortages (i.e., DRAM/SoC), which impacted both sales and working capital cycle. Advantech has resolved the litigation with Rockwell in 2017 with no impact to the business. 2016 sales were NT$42 bn and increased 10.5% YoY, and below the 15% growth target given by the company. The sales shortfall was mainly driven by the slowdown in the US region and slower-than-expected integration of B+B SmartWorx. The region is undergoing a restructuring process which started middle of last year. USD appreciation and falling raw material costs also negatively impacted sales momentum in emerging markets, especially Russia and LatAm. Sales in these regions declined 8%/1% YoY in 2016. China and Taiwan sales increased 5%/17% in 2016. GM decreased 127 bp QoQ to 40.3% from growth in Applied Computing Group, which carries gross margins below the corporate average. Operating margin was 15.8%, in line with our forecast, and increased 19 bp from 2015. Net income was NT$5.7 bn (+11% YoY), in line with CS but below Street of NT$5.7 bn.

Advantech Co., Ltd. (2395.TW / 2395 TT) 5 13 March 2017

Figure 9: Sales by geography Figure 10: 2016 sales growth vs five-year CAGR

$450 15% 40% 37% 12% $400 30% $350 10% 8% 7% $300 5% 20% 4% 14% 5% 12% $250 10% 8% 7% 10% 5% 6% 6% $200 4% 0% $150 0%

$100 -5% -7% -10% -7% $50 -10%

$- -10% -20% Greater China North America Europe Asia/Intercon DMS/E2E Affiliates M&A Greater China North America Europe Asia/Intercon DMS/E2E Affiliates M&A

Sales 2016 % chg 2016 % chg 2011-16 CAGR

Source: Company data, Credit Suisse Source: Company data, Credit Suisse

Advantech re-stated its sales by product segment to better reflect its Industrial IoT business strategy. Embedded Design-In was separated into two product segments called Embedded IoT and Allied DMS. Parts of Advantech Group services (AGS) was then allocated into Allied DMS. Lastly, Smart City Solutions was renamed as Service IoT.

Figure 12: New segment major change crafted Figure 11: Prior sales by product group include Embedded IoT and Allied DMS from Embedded three primary businesses (i.e., 1H16) Design In Services (effective YE 2016)

Source: Company data, Credit Suisse Source: Company data, Credit Suisse Strengthening smart medical capabilities Intelligent systems designed for the healthcare market is one of the fastest growth verticals. IDC forecasts over 8% CAGR reaching US$41 bn in annual sales in 2019. Advantech earlier this year strengthened its intelligent/smart medical offering with Kostec, which folded in new solutions and medical special channel know-how. Kostec annual sales were over US$9 mn in 2014 suggesting a small but important deal, in our view. Kostec will be added into the Service IoT product group.

Advantech Co., Ltd. (2395.TW / 2395 TT) 6 13 March 2017

Figure 13: Intelligent systems for healthcare forecast to reach US$41 bn in 2019 Sales US$ bn 2014 2015 2016 2017 2018 2019E 2016–19 CAGR (%) Communications 557 585 604 620 627 634 1.6% Computing 355 359 363 367 369 375 1.0% Consumer 241 272 306 323 355 386 8.1% Energy 29 30 32 36 39 43 10.0% Healthcare 22 28 33 35 39 41 8.3% Industrial 182 195 198 209 218 225 4.3% Retail 18 19 19 19 19 19 0.1% Transportation 101 117 131 147 165 184 12.0% Subtotal 1,504 1,605 1,686 1,757 1,830 1,907 4.2%

Source: Company data, IDC, Credit Suisse

■ Kostec profile. Founded in 2003, Kostec manufactures medical grade and industrial LCD imaging monitors and displays. Its medical product offerings include diagnostic, modality imaging, clinical, surgical, operating room and ultrasound imaging solutions. Its solutions have met a series of certifications including ROHS, ISO and FDA. Kostec is Korea-based with main branch offices in America and the Netherlands; and sales and technical services offices in 16 countries globally. Kostec sources LCD and components from Japan Display, LG, Sharp, Panasonic, Innolux and AUO and has in- house manufacturing.

■ Business synergies. Advantech's medical IPC solutions are primarily designed into medical tablets, carts, computing platforms, healthcare infotainment terminals and medical monitors. Advantech has a very limited medical monitor and display portfolio only for clinical use. We view the partnership with Kostec as significantly expanding its medical grade monitor and display offerings in addition to offering vertical expertise. Advantech said it will leverage Kostec's strength of business in South Korea, Southeast Asian, and North American markets to grow its smart medical business. Advantech medical solutions are included in the Smart City solutions strategic business group. 1H16 revenues were US$46.4 mn, flat YoY and 7% of sales.

■ Taiwan competition. Taiwan IPC including Avalue (3479.TWO) and Onyx (6569.TWO) are close peers in the field with both generating over half of the sales from medical IPC systems. Compal owns 21.3% of Avalue with the initial investment made in 2014. Avalue's acquired 33% stake on Goomedi Lab in 2016 targeting the medical display market. Onyx also manufactures medical displays and Asustek is its ultimate parent. Click here for a company update in December 2016. Litemax (4995.TWO) specialises in industrial PC, and healthcare is one of its key verticals.

Figure 14: Kostec product portfolio Figure 15: Kostec sales performance

Source: Company data, Credit Suisse Source: Company data, Credit Suisse

Advantech Co., Ltd. (2395.TW / 2395 TT) 7 13 March 2017

CS Industrial PC Index update We update the Credit Suisse Industrial PC Index, which now includes 32 companies. We track these companies closely to gauge the health of the industrial PC sector, and also as a benchmark for Advantech. We have added Partner Tech, AAEON and Onyx to our index. Taiwan Industrial PC sector sales reach NT$161 bn (or US$5 bn) in 2016, an increase of 9% YoY. Sector sales increased 15% compounded in the last three years. AAEON, Ennoconn, and Posiflex reported the top-three fasted growth rates, while Even, XAC Automation and AIC were the worst performing. Advantech 10% sales growth was above the sector.

Figure 16: Advantech 10% sales growth was above the sector average

40% 30% Above sector average 20% 10% 10% 0% -10% -20% -30% Below sector average -40%

-50%

Cipherlab NEXCOM ATEN Winmate

Aaeon Ennoconn Lanner Advantech Partner Tech Portwell XAC Automation

ICP ICP DAS IEI Integration Aplex Axiomtek Even

Avalue Adlink AEWIN AIC

Posiflex Onyx Vivotek Firich Litemax Nextron Caswell

Ibase Arbor

UniTech UniTech Elec. Flytech DFI DFI Inc.

Source: Company data, Credit Suisse

Advantech Co., Ltd. (2395.TW / 2395 TT) 8 13 March 2017

Figure 17: Credit Suisse Taiwan Industrial PC Index (listed by market cap)

Market Industrial Governmen Medical Power Retail Tranportation Ticker Company name Company name Founded Description Banking Gaming Smart City Telecom cap (US$) Manufacturing tMilitary Healthcare Energy Hospitality Logistics

2395.TW Advantech Co., Ltd. 1983 $5,171 Designs and manufactures industrial computers and embedded systems under its own brand

6414.TW Ennoconn 1999 $1,107 Designs and manufactures industrial computers and embedded systems for third parties

6166.TW ADLINK 1995 $514 Designs and manufactures industrial computer and embedded systems.

3022.TW IEI 1997 $531 Designs and manufactures industrial computers and system for third parties and its own brand

Designs and manufactures data communications switches and extenders and related 6277.TW ATEN 1979 $312 peripherals

6416.TWO Caswell 2007 $244 Design and manufacture communication appliance and storage

8050.TWO IBASE 2000 $240 Designs and manufactures embedded computer solutions

3454.TW Vivotek 2002 $221 Design and manufactures of IP surveillance solutions

3088.TWO Axiomtek 1990 $148 Designs and manufactures industrial computers and embedded systems

2397.TW DFI Inc. 1981 $191 Designs and manufactures embedded computer solutions

3479.TWO Avalue 2000 $130 Design and manufactures embedded system, panel PC, and intelligent systems

6105.TWO Portwell 1993 $130 Designs and manufactures industrial computers and embedded systems

8234.TWO NEXCOM 1992 $149 Designs and manufactures intelligent solutions

6245.TWO Lanner Elec 1986 $148 Designs and manufactures industrial networking equipment and appliances

3693.TWO AIC 1996 $85 Design and manufactures server/storage and industrial PC

3416.TWO WinMate 1996 $110 Design and manufacturers digital signage and embedded panel PCs

3594.TWO Arbor 1993 $42 Designs and manufactures industrial computing solutions

Designs and manufactures specialized LCD displays and display modules for various 4995.TWO Litemax 2000 $38 applications

3564.TWO AEWIN 2000 $28 Designs and manufactures embedded and networking solutions

8147.TWO Nextron 1986 $31 Designs and manufactures embedded and industrial PC connectors

8076.TWO FIRICH 1995 $475 Design and manufacturers point-of-sale systems, gaming, and related peripherals

6206.TW Flytech 1984 $509 Design and manufacturers point-of-sales systems and digital signage systems

8114.TW Posiflex 1984 $405 Design and manufacturers its own brand of point-of-sales systems and digital signage systems

6579.TWO AAEON 1992 $362 Designs and manufactures embedded computer solutions. Merged with Asustek in 2011

5490.TWO XAC 1993 $170 Design and manufacture payment solutions

6569.TWO ONYX 2010 $136 Designs and manufactures medical grade IT products and systems under its own brand

3097.TWO Partner Tech 1990 $95 Designs and manufactures customized PC-based, open architecture POS

6160.TWO Cipherlab 1988 $56 Designs and manufactures automatic identification and data capture (AIDC)

3577.TWO ICP DAS 1993 $49 Designs and manufactures automatic identification and data capture (AIDC)

6441.TWO iBase Gaming 2000 $31 Designs and manufactures embedded systems

6570.TWO Aplex Technology 2004 $29 Design and manufactures industrial computers

3652.TWO Unitech elec. 2000 $36 Designs and manufactures automatic identification and data capture (AIDC)

6436.TWO Even Systems 2000 $24 Designs and manufactures embedded systems

Source: Company data, Credit Suisse estimates

Advantech Co., Ltd. (2395.TW / 2395 TT) 9 13 March 2017

Phase 2 of Advantech IoT strategy We attended the Smart City Summit & Expo in Taipei, Taiwan held between 21-24 February. We attended the keynote presentations from Advantech's management team, amongst other session on discussion on the future of Smart City. We highlight key points from Advantech's presentation on becoming a leading B2B IoT solutions provider, and its recent innovations in Smart Retail and Hospitality. IoT Strategic Overview Speaker: Mr. KC Liu, Chairman of Advantech

■ Advantech's Industrial IoT strategy. Advantech proposes an IoT solution architecture based on four layers—IoT sensing solutions and embedded platforms & edge intelligent servers which are located at the edge of the network, and solution ready platforms and domain specific cloud services which are located in the Cloud. Advantech’s primary competitiveness is in the Embedded Platforms & Edge Intelligence Servers (EIS) layer, and derives over 90% of its sales. Advantech is pushing into the IoT sensing solution layer, which consists of sensors, modules, and a variety of wireless communication technologies including WiFi, Bluetooth, LoRa, etc., and of which Advantech also has some exposure on. The Solution Ready Platform (SRP) layer is an IoT solution package combining both hardware and software intelligence. Advantech envisages the growing importance of SRP as a value-add to customers and has been the focus area of development for the company the past few years. The last layer is vertical-specific Domain Specific Cloud Services (SaaS). Advantech dubbed the layer as the core of IoT architecture and is mainly provided by Advantech’s customers or System integrator (SI). Please see Figure 18 below. ■ Phases of IoT evolution. Chairman Liu laid out the IoT development planning over the next few decades. Advantech is in Phase 1 of its evolution plan or the IoT devices phase. Advantech said it will start to migrate to Phase 2, or the IoT hardware + software solutions integration phase. Advantech sees limited peers competing in the field and for which Advantech has been investing heavily on. Advantech targets to become the industry leader entering Phase 2 in IoT SRP/EIS stage. Mr. Liu highlighted the mass market opportunity is currently captured by Advantech’s customers (i.e., SI), or Phase 3. Advantech’s strategy is to invest and incubate start-ups and it also plans to establish cooperated venture in the near future. Mr. Liu said that currently all players competing in the field are relatively small. Advantech’s investment and initiative will allow the company to expand and create a closer relationship with its downstream customers. In 2027 or ten years later, Mr. Liu expects Advantech will be a matured player in Phase 2 (hardware + software solutions provider) while also tap into Phase 3 from the investment and incubation initiatives. ■ New business structure. Advantech proposed a brand new business segmentation following the introduction of Allied DMS business model and the grand opening of Linkou campus. The newly opened Linkou campus now becomes the central hub of hardware platforms and production as well as the headquarters for Allied DMS business (i.e., Embedded IoT and Allied DMS). The Nehu campus serves as software and solution specific business hub (i.e., Industrial IoT and Service IoT).

Advantech Co., Ltd. (2395.TW / 2395 TT) 10 13 March 2017

Figure 18: IoT ecosystem with Advantech core strength in Embedded Platforms & Edge Intelligence Servers; and IoT sensing platforms

Source: Company data, Credit Suisse

Figure 19: Next phase of Advantech's IoT evolution: moving into IoT SRP and EIS through alliance and innovation

Source: Company data, Credit Suisse

Advantech Co., Ltd. (2395.TW / 2395 TT) 11 13 March 2017

Advantech's new Allied DMS business model Speaker: Mr. KC Liu, Chairman of Advantech

■ Challenges facing Industrial IoT mass adoption. The Chairman described the major characteristics and difficulties of an IoT supply chain. Mr. Liu said that the B2B supply chain is different from a B2C one in four areas: (1) customers (i.e., SI/ISV vs consumers); (2) products (i.e., small volume and high mix vs high volume and low variety; (3) economic sharing vs exclusivity between different component suppliers; and (4) product longevity (i.e., 8-10 years vs. 1-2 years of consumer products). Mr. Liu believes these are the primary reasons why IoT market remains much of a discussion than massive market proliferation. Also, there is no one single dominant player due to the immaturity of PaaS development which impedes SI from providing expanding services. In addition, each vertical market on Phase 3 of Advantech’s IoT evolution phase overview is still small, facing high variety and small volume requirement, which prevents the IoT from reaching scale economies. ■ Developing IoT (B2B) ecosystem with Allied DMS. Advantech's Allied DMS business model addresses several business difficulties through the establishment of IoT supply chain. Advantech's Allied DMS service relationship shares core IP freely with SI clients (i.e., GE, Schneider, Siemens, Fujitsu, and NEC) to drive bundled hardware and software solutions. Advantech invites its horizontal peers to develop JV relationships to share the IoT business opportunity. Advantech also proposes a Component Alliance Procurement Service (CAPS), which intends to form a professional, IoT specific supply chain to jointly resolve the impact from small volume and high variety characteristic of IoT industry. Intellitech System (8155.TW), a PCB supplier of which Compal and Advantech respective holds 20%/10%, is one example that Advantech highlighted it has strategically cooperated with, forming this professional Allied DMS CAPS supply chain. ■ Allied DMS—Central kitchen of services. Advantech said the proposed Allied DMS business model resembles a central kitchen of services to facilitate cooperation across business groups. The flow will be uniformly top-down with one joint windows for orders placing, central kitchen for coordinating and sharing resources (i.e., manufacturing) across internal business groups and external partners in meeting different end consumers appetite (i.e., hardware and total solutions for different vertical markets). Combining with joint procurement or CAPS, unnecessary costs and expenses are minimized. In addition, Advantech highlighted it is important for the company to keep its Brand and DMS business group together as Brand serves as an example for actual practicality for Advantech DMS hardware.

Advantech Co., Ltd. (2395.TW / 2395 TT) 12 13 March 2017

Figure 20: Allied DMS as Central Kitchen Services

Source: Company data, Credit Suisse New Era of iRetail IoT Speaker: MC Chiang, President of Service-IoT Group

■ Current obstacles facing brick-and-motor stores. Mr. Chiang highlighted major challenges facing physical stores operators. These include high operating costs, rising competition against E-Commerce vendors and slowing demand. Mr. Chiang said that combining offline with online operation is an irreversible trend. Amazon GO and Alibaba’s Mr. Hippo are the latest examples of this trend. Physical retail stores are limited by technology investment into only POS and logistics. Mr. Chiang believes that new technology in iRetail helps attract consumers and strengthen competiveness. ■ Current iRetail solutions. Advantech offers a variety of retail solutions including Shopping Engagement (digital signage, cloud queuing and smart menu), Cashier Management (loss prevention), Operation Support (environment control and monitoring), and Business Intelligence (heat map and shopper and store traffic analysis). Currently, Advantech has over 1,000 development cases and over 100 of which are in Greater China area including ToysRus and Walmart in the US and Volkswagen in Germany. Overall retail sector contribution to Advantech’s sales is limited but they have plans to grow the business with new iRetail IoT solutions. ■ New intelligent retail IoT technologies. Advantech specialises in the hardware layer offering various solutions include digital signage, POS systems, AIO service touch computers. The company through partnership has started to offer retail SRPs. Mr. Chiang believes its iRetail SRP (i.e., UShop) is the most important layer as it provides greatest value-add to client by using various sensors and systems to provide visual business intelligent solutions, which can help maximise store traffic. Mr. Chiang said Advantech will seek to partner with other software and solution vendors to expand and enrich UShop content.

Advantech Co., Ltd. (2395.TW / 2395 TT) 13 13 March 2017

Figure 21: Intelligent retail and hospitality solutions Figure 22: WISE-PaaS business scope

Source: Company data, Credit Suisse Source: Company data, Credit Suisse Advantech: WISE-PaaS to facilitate Taiwan IoT/EI- PaaS industrial alliance Speaker: Allan Yang, Corporate Technical Officer of Advantech

■ WISE-PaaS—IoT edge intelligence PaaS. WISE-PaaS is a software platform that helps customers develop domain-focused solutions. Mr. Yang said that WISE-PaaS for IoT resembles Android for smartphone where Advantech/Google provide semi-ready and modular platform to SI/vendors for the ease of creating domain specific applications/UI development. WISE-PaaS offers: (1) data collection and a platform for internet connectivity; (2) equipment management and monitoring; (3) IoT data, equipment and network security control; (4) total solution package for initial operation; and (5) cloud management and service expansion. Advantech is working with SI for SaaS Enabling and international vendors on visualisation and Data Analytics such as Microsoft Azure and IBM Bluemix for big data analysis and machine learning modules. ■ Industrial cooperation planning. Mr. Yang said Advantech would establish an operationally independent company as an EI-PaaS provider in the long term. The business model will center on providing its clients a secure and safe cloud platform for easier vertical-targeted application development and profits from leasing this platform by monthly usage. For the next 1-1.5 years, Advantech will continue to invest and enhance WISE-PaaS functionality and reliability. The second stage will kick start in 2018 when Advantech plans to share this EI-PaaS with its peers and clients to speed up the maturation of this EI-PaaS business.

Advantech Co., Ltd. (2395.TW / 2395 TT) 14 13 March 2017

Companies Mentioned (Price as of 10-Mar-2017) ACCL (8155.TWO, NT$37.0) ADLINK (6166.TW, NT$73.5) AEWIN (3564.TWO, NT$42.35) AIC (3693.TWO, NT$68.3) ATEN (6277.TW, NT$81.3) AU Optronics (2409.TW, NT$11.9) Advantech Co., Ltd. (2395.TW, NT$254.0, OUTPERFORM, TP NT$300.0) Alibaba Group Holding Limited (BABA.N, $103.24) Alphabet (GOOGL.OQ, $857.84) Amazon com Inc. (AMZN.OQ, $853.0) Arbor (3594.TWO, NT$22.7) Asustek (2357.TW, NT$279.0) Avalue (3479.TWO, NT$58.5) Axiomtek (3088.TWO, NT$58.4) Caswell (6416.TWO, NT$126.4) Cipherlab (6160.TWO, NT$25.45) Compal Electronics (2324.TW, NT$19.15) DFI Inc. (2397.TW, NT$51.8) Ennoconn (6414.TW, NT$451.0) FIRICH (8076.TWO, NT$59.7) Flytech (6206.TW, NT$100.5) Fujitsu (6702.T, ¥668) General Electric (GE.N, $29.66) IBASE (8050.TWO, NT$63.1) ICP DAS (3577.TWO, NT$35.1) IEI (3022.TW, NT$50.3) Innolux Corporation (3481.TW, NT$12.1) International Business Machines Corp. (IBM.N, $177.18) Japan Display (6740.T, ¥265) LG Corp (003550.KS, W62,600) Lanner Elec (6245.TWO, NT$44.4) Litemax (4995.TWO, NT$34.3) Microsoft Corporation (MSFT.OQ, $64.73) NEC (6701.T, ¥286) NEXCOM (8234.TWO, NT$32.95) Nextron (8147.TWO, NT$38.7) Panasonic (6752.T, ¥1,284) Partner Tech (3097.TWO, NT$39.15) Portwell (6105.TWO, NT$39.4) Posiflex (8114.TW, NT$172.5) Rockwell Automation (ROK.N, $152.18) Schneider Electric (SCHN.PA, €64.51) Sharp (6753.T, ¥382) Siemens (SIEGn.DE, €124.05) Unitech elec. (3652.TWO, NT$24.0) Vivotek (3454.TW, NT$86.0) Volkswagen (VOWG.DE, €143.25) Wal-Mart Stores, Inc. (WMT.N, $69.86) WinMate (3416.TW, NT$56.8) XAC (5490.TWO, NT$56.0) onyx (6569.TWO, NT$233.0)

Disclosure Appendix Analyst Certification I, Thompson Wu, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Advantech Co., Ltd. (2395.TW)

2395.TW Closing Price Target Price Date (NT$) (NT$) Rating 11-May-16 219.00 270.00 O * 31-Oct-16 257.00 307.00 10-Jan-17 257.00 305.00 * Asterisk signifies initiation or assumption of coverage.

OUTPERFORM

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities

Advantech Co., Ltd. (2395.TW / 2395 TT) 15 13 March 2017

As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Ou tperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total retu rn potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:

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Target Price and Rating Valuation Methodology and Risks: (12 months) for Advantech Co., Ltd. (2395.TW) Method: Our NT$300 target price for Advantech is based on 29x 2017E EPS (earnings per share). We argue a 29x multiple is fair as we expect Advantech's growth to accelerate to 10.5% compounded from 2016-19E. In addition, we rate the stock OUTPERFORM because we believe Advantech's superior financial performance and returns warrant it trading at a premium valuation to its sector peers. Risk: We believe the key risks to our OUTPERFORM rating and 12M target price of NT$300 include: (1) macro weakness which could push out smart city build-outs; (2) China macro in particularly given the country has been aggressively investing in manufacturing automation; (3)

Advantech Co., Ltd. (2395.TW / 2395 TT) 16 13 March 2017

miss-step in technology transitions, which could impact ability to win new projects; and (4) execution of M&A delay entry into new channels, regions, or markets.

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Advantech Co., Ltd. (2395.TW / 2395 TT) 17 13 March 2017

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When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to pay the purchase price only.

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