Global Smartphones 5G to Drive Smartphone Recovery to 1.64Bn Units by 2022E

5 November 2019 Global

EQUITIES Global smartphones 5G to drive smartphone recovery to 1.64bn units by 2022E

Key points  Smartphone market demand recovery starting 2H20 as 5G smartphone adoption accelerates with 230m/584m units in 2020E/2021E.  Trend 1: 5G component $ content increase. Our top buys: Advantest, KYEC, Murata, Samsung E, SEMCO, Shengyi, TDK, TSMC and Win Semi. Inside  Trend 2: $ content growth with multi-camera specs upgrade. Top buys: Largan, Semco, Sony and new initiations Sunny Optical and Q Tech.

Focus charts 2

Investment summary 3 Smartphone recovery driven by 5G 11 Smartphone volume recovery driven by 5G Volume recovery benefits top six brands 19 We believe 5G smartphones will create a wave of replacement demand in the Smartphone trend 1: 5G $ content in coming five years. With few 5G premium smartphones launched in 2019 and components 26 more product and network roll-out announcements expected 2020, we see 5G Smartphone trend 2: multi-camera upgrade 30 smartphone shipments accelerating to 230m, 584m and 860m units in 2020, Appendices 35 2021 and 2022, respectively. We forecast overall smartphone demand in 2019 Sunny Optical (2382 HK) 45 will decline by 1.7% prior to 5G network readiness and total volume demand will Q Technology Group (1478 HK) 72 recover by 0.5%, 2.6% and 4.0% to 1.53bn, 1.58bn and 1.64bn units in 2020-22E, AAC Technologies (2018 HK) 93 respectively, on the 5G upgrade. The installed base of smartphones is now very large at about 5.1bn and 3.3 year old, and we expect replacement years to stay

Analysts flattish at 3.4 years through the 5G upgrade.

Macquarie Capital Limited

Cherry Ma +852 3922 5800 Volume recovery benefits top six smartphone brands [email protected] The top six brands – Samsung, Huawei, Apple, Xiaomi, Oppo and Vivo – are Nicolas Baratte +852 3922 5801 consolidating the market, with a 70% market share in 1H19, up 3ppt YoY. The US [email protected] trade ban on Huawei has widely impacted sentiment but we expect the overseas Fiona Liu +852 3922 1368 market impact to be limited to Europe (Flagship), while Huawei’s mid-rangers or [email protected] priced\-down legacy models to still sell well in Latam and MEA. We expect

Erica Chen +86 21 2412 9024 Huawei’s smartphone volume to reach 240m, 254m and 323m units in 2019, [email protected] 2020 and 2021E, respectively, with global market shares of 16%, 17% and 21%.

Macquarie Capital Securities (Japan) Limited 5G to increase $ content in select components Damian Thong, CFA +81 3 3512 7877 [email protected] 5G smartphone will have double the amount of bandwidth compared to a 4G

Hiroshi Taguchi +81 3 3512 7867 smartphone; as a result, we expect the silicon content $ value including SoC/ [email protected] baseband, front-end RF to increase by 30-35% while expanding demand for

passives, substrates and battery. Per Tech Insight, Sub-6GHz 5G-specific Macquarie Capital Limited, Taiwan Securities Branch components in a flagship smartphone cost about US$65 more compared to the Patrick Liao +886 2 2734 7515 [email protected] 4G version. Our top picks for the 5G theme are: Advantest, KYEC, Murata, Samsung E, SEMCO, Shengyi, TDK, TSMC and Win Semi. Kaylin Tsai +886 2 2734 7523 [email protected] Multi-camera upgrades drive volume and ASP growth Jeffrey Ohlweiler +886 2 2734 7512 [email protected] We have surveyed a total of 132 smartphones launched in 2019 by the top six vendors. About 20% of front cameras use motorised pop-up design; over 60% of

Macquarie Securities Korea Limited back cameras are triple or quad cameras; 50% of the main cameras use Daniel Kim +82 2 3705 8641 [email protected] resolution lenses above 40-48MP; over 40% of the new devices use under- display fingerprint sensors. On average, there are 3.7 cameras per device, with

Macquarie Capital Securities (Malaysia) Sdn. Bhd. 1.0 front camera and 2.7 back cameras. Over 2019/20/21E, we forecast triple-

Ben Shane Lim +60 3 2059 8868 camera penetration to reach 18%/34%/45%, while quad-camera upgrade could [email protected] happen in parallel with 1%/6%/16%. Our top picks within the camera supply chain

are: Largan, Semco, Sony, Sunny Optical and Q Tech. Please refer to page 113 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.

Macquarie Research Global smartphones

Focus charts

Fig 1 Smartphone shipment by 3G/4G/5G technology Fig 2 Smartphone market share of the top six brands

(m units) 1,800 100% 18% 1,600 90% 24% 33% 29% 80% 36% 1,400 44% 41% 9% 1,200 70% 8% 8% 9% 8% 9% 1,000 60% 7% 8% 10% 3% 6% 6% 7% 9% 50% 2% 5% 8% 800 5% 6% 8% 12% 4% 13% 600 40% 12% 16% 14% 14% 13% 400 30% 17% 21% 7% 9% 10% 13% 16% 200 20% 0 10% 23% 21% 21% 19% 20% 21% 22% 0% 2015 2016 2017 2018 2019E 2020E 2021E 3G 4G 5G Samsung Huawei Apple Xiaomi Vivo Oppo Others

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Fig 3 Logic semi and RF in smartphone value Fig 4 Camera industry value and % of total

(US$bn) (US$bn) 77.6 80.0 75.5 71.6 60 8% 66.1 70.0 63.0 48.6 7% 62.2 62.3 50 57.0 58.3 45.4 60.0 41.4 6% 40 37.1 50.0 33.1 5% 36.0 40.0 32.3 32.9 30 4% 28.9 22.8 23.5 30.0 26.4 21.3 21.9 3% 16.7 20 15.5 20.0 14.3 15.6 12.9 2% 10.0 10 1% 0.0 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E - 0% 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

Logic semi RF Industry value - camera % of total smartphone value

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Fig 5 Top picks with Outperform ratings China/ Hong Kong Korea Japan Taiwan 5G top picks Antenna SEMCO (009150 KS) Back end JCET (600584 CH) ASE (3711 TT) KYEC (2449 TT) Baseband, AP Samsung Elec (005930 KS) TSMC (2330 TT) Battery Samsung SDI (006400 KS) TDK (6762 JP) GaAs foundry WinSemi (3105 TT) Passives SEMCO (009150 KS) Murata (6981 JP) PCB, substrate Shengyi (600183 CH) SEMCO (009150 KS) RF component Murata (6981 JP) SPE Advantest (6857 JP) Camera upgrade top picks Camera module Sunny Optical (2382 HK) SEMCO (009150 KS) Q Tech (1478 HK) Lens Sunny Optical (2382 HK) Largan (3008 TT) Sensor Sony (6758 JP) Source: Company data, Macquarie Research, November 2019

5 November 2019 2 Macquarie Research Global smartphones

Investment summary

Smartphone volume recovery • 5G smartphones could create a wave of replacement demand in the coming five years. We estimate 5G smartphone volume will reach 230m units in 2020 and 1.29bn units by 2024, with penetration reaching 76% of smartphone shipments.

• We expect global smartphone volumes to decline by 1.7% in 2019 but to recover by 0.5%, 2.6% and 4.0% in 2020, 2021 and 22E to 1.53bn, 1.58bn and 1.64bn units, respectively, driven by 5G adoption and a handful of better specs, cameras being the most salient.

• Smartphone penetration as a percentage of installed base is at 64% globally in 2019, with a massive installed base of 5.1bn phones, on our estimates, which is ageing rapidly from 2.6 years in 2015 to 3.3 years old in 2019. This is why the market is consolidating, with the top six brands growing and virtually all others declining. We believe the 4G to 5G upgrade will slow the replacement cycle to about 3.4 years over 2020-23E as increasing penetration of 5G network and services prompts consumers to upgrade their devices.

• Smartphone ASP has been increasing at an average of 7.3% in the past three years to US$302 in 2019 as consumer’s trade up. We think 5G smartphone affordability will not hinder adoption. The initial cost increase from 4G to 5G is about US$65 for premium phones. Blended ASP is expected to reach US$325, US$350 and US$366 over 2020, 2021 and 2022, respectively.

• We see smartphone industry value witnessing a five-year CAGR of 7.4%, from US$462bn in 2019 (ASP US$302 x 1.53bn units) to US$638bn in 2023 (ASP US$356 x 1.68bn units).

Fig 6 Smartphone shipment by 3G/4G/5G technology Fig 7 Smartphone shipment by 3G/4G/5G technology

(m units) (m units) 1,600 1,800 1,400 1,600 1,200 1,400 1,000 1,200 1,000 800 800 600 600 400 400 200 200 0 0

3G 4G 5G 3G 4G 5G

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Fig 8 Smartphone volume and ASP Fig 9 Smartphone industry value and growth

(m units) (US$) (US$ bn) 1,750 400 700 638 655 14% 1,682 1,693 1,700 380 601 1,640 600 551 12% 1,650 360 499 1,577 462 10% 1,600 1,555 340 500 446 1,537 1,537 412 1,550 1,529 320 8% 1,496 400 370 366 1,500 300 6% 1,450 1,424 280 300 4% 1,400 260 200 2% 1,350 240 1,300 220 100 0% 1,250 200 0 -2% 2015 2016 2017 2018 2019E2020E2021E2022E2023E2024E 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

Smartphone volume ASP (RHS) Industry value YoY (RHS)

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 3 Macquarie Research Global smartphones

Volume recovery benefits top six smartphone brands • Huawei’s still growing despite the trade ban. Subsequent to the US-China trade ban and entity list, Huawei lost access to Google Mobile Services for new devices after May 2019. Huawei has redirected its growth strategy back to China and gained 6ppt of market share, reaching 35% in 2Q19 compared to 4Q18. According to Huawei’s 3Q19 result, smartphone volumes in 9M19 increased by 26% to 185m units. China accounts for about 55-60% of Huawei’s total units.

• We expect the trade ban impact to be limited to Europe (flagship market), but Huawei’s mid- rangers or priced-down legacy models could still sell well in Latam and MEA. We forecast Huawei’s smartphone volume will reach 240m, 254m and 323m units in 2019, 2020 and 2021E, representing global market share of 16%, 17% and 21%, respectively.

• Market share shifts of Android brands. With the intensifying competition with Huawei in China, we forecast Oppo, Vivo and Xiaomi’s domestic market share in aggregate to decline from 50% in 2018 to 47%, 46% and 43% in 2019, 2020 and 2021, respectively. We expect these brands to focus their resources overseas to grab market share on Huawei’s weakness. The eventual beneficiaries of Huawei weakness in EM will be other Chinese brands.

• Samsung is the direct beneficiary of the Huawei void in Europe above the US$600 price point but is facing stiff competition in the Indian market from other Chinese brands that are losing share to Huawei in China. Samsung is likely to grow its smartphone shipments in 2020 by over 8% YoY, the highest since 2013. This is due largely to the muted competition in Europe (from Huawei troubles) and the rising 5G phone market. Its 5G phone should sell mainly in Korea, the US, and to a certain degree Japan, since the 5G-ready iPhone will become available only in 4Q20. The company has a limited presence (1% share) in China, the major 5G phone market for the next three years. We see two swing factors to its smartphone growth and profitability: First, the company plans to grow ODM volume, mainly for low-end markets such as India, in order to fend off rising competition from Chinese smartphone vendors such as Xiaomi and Oppo, and to shore up its profitability. Second, the company is pondering its foldable phone line-up in 2020, especially about pricing strategy.

Fig 10 Global smartphone market share of top 6 brands

100% 90% 25% 20% 33% 29% 80% 41% 36% 44% 9% 8% 70% 8% 9% 8% 9% 60% 7% 8% 10% 3% 6% 6% 7% 9% 50% 2% 5% 8% 5% 4% 6% 8% 12% 12% 13% 40% 16% 14% 14% 13% 30% 17% 21% 7% 9% 10% 13% 16% 20% 10% 23% 21% 21% 19% 20% 21% 20% 0% 2015 2016 2017 2018 2019E 2020E 2021E Samsung Huawei Apple Xiaomi Vivo Oppo Others

Source: Gartner, Macquarie Research, November 2019

5 November 2019 4 Macquarie Research Global smartphones

Smartphone trend 1: 5G to bring $ content increase in selective components • Components with a chunky bill of material growth in a 5G smartphone include AP/baseband, RF component and substrates. Silicon content is expected to increase by 30-35% in a 5G smartphone today compared to 4G. Per Tech Insight’s estimate, there’s about US$65 incremental Sub-6GHz 5G component costs in the Samsung Galaxy S10+ 5G compared to the regular S10+ (4G version):

 An additional US$32 for Samsung’s 5G baseband  A US$15 increase in RF components on more RF front-end content for the increasing amount of bandwidth for Sub-6GHz 5G

 A US$13.5 increase in substrates to accommodate more silicon content  Per IHS estimates, the RF front-end component of the Sub-6GHz + mmWave version of the Samsung S10+ would cost an additional US$49 compared to the 4G version

Fig 11 Component costs comp of Samsung’s Galaxy S10+ Sub 6GHz 5G vs 4G version

(US$) 90 5G specific increase 80 70 60 +$15 50 40 +$32 +$13.5 30 20 +$1.0 +$3.0 10 0

Samsung Galaxy S10+ Samsung Galaxy S10+ 5G

Source: Tech Insight, Macquarie Research, November 2019

Fig 12 Samsung Galaxy S10+ Sub 6GHz 5G vs S10+ 4G Samsung Samsung Galaxy Components cost (US$) Galaxy S10+ 5G S10+ 4G +/- Extra items in 5G version

Key 5G components AP and baseband 70.5 70.5 - 5G baseband 32.0 - 32.0 Exynos 5100 5G modem RF component 46.0 31.0 15.0 Qorvo FEM, Shannon 5500 RF transceiver, etc Substrates 26.0 12.5 13.5 Battery 11.5 10.5 1.0 10% more capacity Power management/ audio 10.0 7.0 3.0 Shannon PMIC Others Display 90.0 86.5 3.5 8% bigger Cameras 62.5 56.5 6.0 Additional ToF 3D camera DRAM 37.5 39.0 -1.5 NAND 18.0 11.5 6.5 Casing 32.5 29.0 3.5 More complex structure for antennas Connectivity 10.0 10.5 -0.5 Others 29.5 41.5 -12.0 Assembly & Testing 14.0 14.0 - Key 5G components 196.0 131.5 64.5 Total BOM 490.0 420.0 70.0 Source: Tech Insight, Macquarie Research, November 2019

5 November 2019 5 Macquarie Research Global smartphones

• Silicon content increase in the 5G smartphone should lift component cost by about US$65 in a flagship smartphone in 2019, per Tech Insight’s findings. According to Gartner, smartphone semiconductor industry value will grow from US$115bn in 2018 to US$125bn by 2023E. We estimate the application processor and baseband (discrete chips and SoC) market at US$66.1bn in 2020, increasing to US$77.6bn by 2023.

Fig 13 Logic semi and RF in smartphone value

(US$bn) 75.5 77.6 80.0 71.6 66.1 70.0 63.0 62.2 62.3 57.0 58.3 60.0 50.0 36.0 40.0 32.3 32.9 26.4 28.9 30.0 21.9 20.0 14.3 15.6 16.7 10.0 0.0 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E Logic semi RF

Source: Macquarie Research, Gartner, November 2019

• Other large dollar content increases include:  RF front-end module industry value to witness a CAGR of 14% from US$15bn in 2017 to US$35bn in 2023, per Yole Development.

 Substrate: overall global advanced substrates industry revenue to see a CAGR of 8% from US$7.9bn in 2018 to US$12.7bn in 2024, per Yole Development. 5G smartphones will help improve supply-demand for the BT segment with more content (size, components) for 5G SoC and AIP (antenna in package).

 PCB: Global PCB revenue to see a CAGR of 3.7% from US$62bn in 2018 to US$75bn in 2023, driven mainly by 5G, according to Prismark. For FPCB, 5G will bring increased adoption of modified PI and LCP. For HDI, it will trigger upgrades to any-layer HDI or even SLP, which is also positive for its CCL manufacturers.

• High-end and premium 5G smartphones are increasing ASP to reflect cost increase for 5G components and other differentiating features, such as multi-cameras, curve displays, haptics, etc. Sub-6GHz-only 5G smartphones have lower RF front end content/costs compared to a global model with mmWave capability. In the mid to low-end segment, smartphone OEMs might have to reduce cost or limit upgrades in other components, including display, casing, fingerprint and acoustic, to subsidise the 5G components’ initial cost increase. 5G implications for the supply chain

• A large shift in Huawei supply chain could be followed by other Chinese brands. • MLCC and substrate sectors have suffered from oversupply and poor price discipline, but this has changed since 2017 due to limited capex and shortages in some product segments. The 5G upgrade could increase tightness in the very high-end segments.

• We are not positive on the PCB and flexible PCB sectors, which have too many suppliers and usually high price competition and/or excess capacity.

5G top buys: • Advantest (6857 JP): increasing demand for chip testers, higher complexity of 5G SoCs will increase test times and drive need for chip tester upgrades in areas such as RF testing.

• KYEC (2449 TT): benefits from longer testing time for 5G chips and HiSilicon’s orders for planned production.

5 November 2019 6 Macquarie Research Global smartphones

• Murata (6981 JP): increasing MLCC sales per smartphone; 5G smartphone will require small size and higher capacitance MLCC. For both Sub-6GHz and mmWave 5G, new RF front end technology will be required to manage higher frequencies, which is positive for $ content per smartphone. There could be potential market share gains with Chinese smartphone makers as they move away from US suppliers.

• Samsung Electronics (005930 KS): could benefit from Huawei high-end weakness in Europe. Samsung should benefit from the continued consolidation of the smartphone market to the top-6 brands and from higher-ASP 5G smartphone. Also, 5G should trigger a DRAM content increase.

• SEMCO (009150 KS): MLCC 20% volume growth with 10% ASP erosion is a positive. The strong FC-BGA semicon substrate market should persist till the end of 2020 at least, due to shortages.

• Shengyi (600183 CH): The world’s second-largest laminate company in capacity, with 12% market share, is Huawei’s third-largest PCB supplier for telecom equipment. In 5G’s high- speed, high-frequency fields, SYTECH is closing the technology gap, as its products could compete with and replace some of industry leaders (Rogers, Panasonic, etc). The company started shipping high-frequency laminate in 2018, which we expect to meaningfully contribute in 2019.

• TDK (6762 JP): will increase Li-ion battery sales for 5G smartphones, which require high-power batteries. TDK dominates the smartphone battery business with 35% global market share in 2018 and has technological advantages.

• TSMC (2330 TT): benefits from the increasing silicon content in 5G devices; we estimate like- for-like 30% increase in AP/BB die size. This will be compounded by Apple and Huawei moving to 5nm in 2020.

• Win Semi (3105 TT): benefits from the additional PAs for 5G frequencies and increasing 5G base station infrastructure demand, driven by Huawei’s orders shifting away from the US supply chain.

Fig 14 Top picks for 5G content upgrade with Outperform ratings (% exposure to smartphone and base station) China Korea Japan Taiwan Antenna SEMCO (009150 KS) 75% ASE (3711 TT) 20% Back end JCET (600584 CH) 15% KYEC (2449 TT) 35% Samsung Elec Baseband, AP TSMC (2330 TT) 50% (005930 KS) 65% Battery Samsung SDI (006400 KS) 10% TDK (6762 JP) 40% GaAs foundry WinSemi (3105 TT) 50% Passives SEMCO (009150 KS) 75% Murata (6981 JP) 50% PCB, substrate Shengyi (600183 CH) 35% SEMCO (009150 KS) 75% RF component Murata (6981 JP) 50% SPE Advantest (6857 JP) Source: Macquarie Research, November 2019

5 November 2019 7 Macquarie Research Global smartphones

Fig 15 Stocks with high 5G exposure Smartphone + base station Company Ticker Analyst comments exposure Analyst Antenna Luxshare 002475 CH - NR Base station antenna, filters, 5G CPE RRU/AAU, LCP antenna 80-90% Non-rated SEMCO 009150 KS - OP 75% Daniel Kim Sunway 300136 CH - NR LDS and LCP antenna for Android smartphones 80-85% Non-rated Baseband, AP TSMC 2330 TT - OP Increasing silicon content 50% Patrick Liao Samsung 005930 KS - OP 5G SoC, smartphones 65% Daniel Kim MediaTek 2454 TT - UP 5G SoC Patrick Liao Qualcomm QCOM US - NR 5G SoC Non-rated Back-end ASE 3711 TT - OP 20% Patrick Liao Inari INRI MK - UP The single-source OSAT for Broadcom’s FBAR RF filters, supplying high-mid Ben Shane Lim band filters for Apple and Samsung. Additional content growth. JCET 600584 CH - OP 15% Patrick Liao KYEC 2449 TT - OP Longer testing time for 5G chips, HiSilicon for base station. 35% Patrick Liao Battery Desay 002920 CH - NR 5G smartphone requires high power battery. Non-rated TDK 6762 JP - OP 5G smartphone requires high power battery. TDK dominates smartphone Hiroshi Taguchi battery business (35% global market share in 2018) and to benefit from the increasing Li-ion battery sales for 5G smartphone. Samsung SDI 006400 KS - OP Increasing battery density on higher power consumption 10% Daniel Kim LG Chem 051910 KS - OP 5G smartphone requires high power battery. 1% Anna Park Sunwoda 300207 CH - NR 5G smartphone requires high power battery. Non-rated PCB/substrates Kinsus 3189 TT - N An IC substrate maker and benefits from 5G in (1) increasing ABF substrate 50%-60% Kaylin Tsai demand from FPGA in base stations and (2) increasing BT substrate demand from 5G components (RF IC, antenna) in smartphones. SEMCO 009150 KS - OP 75% Daniel Kim Shengyi Tech 600183 CH - OP Huawei’s 3rd largest PCB supplier for telecom equipment. World’s 2nd largest 30-40% Erica Chen laminate company in capacity, and it's closing the tech gap with Rogers and Panasonic. Shennan Circuits 002916 CH - N China's second largest PBC maker with 60% of sales contribution from 60-70% Erica Chen telecom clients. 5G migration to lift telecom PCB demand. TTM Technologies TTMI US - NR A supplier of printed circuit boards, backplane, and transceivers into Non-rated smartphones, base stations, and antenna. Unimicron 3037 TT - NR 4th largest PCB supplier in the world with clients including Apple, Huawei 33% Non-rated (smartphone and base station), Intel, AMD, Nvidia, Xilinx, etc. WUS 002463 CH - N Huawei's 2nd largest PCB supplier for telecom equipment. 5G migration to lift 65% Erica Chen telecom PCB demand. Zhen Ding 4958 TT - N Benefit from iPhone antenna FPCB design upgrade from modified PI to LCP Kaylin Tsai Flexium 6269 TT- N and increase in overall antenna FPCB content per box. In 2020 both firms are targeting to penetrate into LCP. From execution track record ZDT may have better chances to get higher allocation. Passives Fenghua Advanced 000636 CH - NR Non-rated KEMET KEM US - NR KEM supplies tantalum polymer into base stations with strong design wins and Non-rated has flex suppression sheets for 5G smartphones (historically Apple). Murata 6981 JP - OP Increase MLCC sales per smartphone. 5G smartphone will require small size Hiroshi Taguchi SEMCO 009150 KS - OP and higher capacitance MLCC, and the top MLCC makers have technological 75% Daniel Kim Taiyo Yuden 6976 JP - OP advantage in that area. Hiroshi Taguchi Sunlord 002138 CH - NR Increasing need of passive component miniaturization (from 0201 to 01005) Non-rated due to limited PCB area size of 5G phone and rising number of usage due to more supported bands (from 40+ bands in 4G to 90+ bands in 5G) RF component Broadcom AVGO US - NR For both Sub-6GHz and mmWave 5G, new RF technology will be required to Non-rated Qorvo QRVO - NR manage higher frequency. Contents per smartphone will increase. Skyworks SWKS - NR Murata 6981 JP - OP Potential to expand the business in RF especially for the business with Hiroshi Taguchi Taiyo Yuden 6976 JP - OP Chinese smartphone makers Hiroshi Taguchi Maxscend 300782 CH - NR Non-rated GaAs foundry SanAn 600703 - NR Non-rated WinSemi 3105 TT - OP 5G base station PA, beneficiary of the US-China trade ban Patrick Liao

5 November 2019 8 Macquarie Research Global smartphones

Fig 15 Stocks with high 5G exposure Smartphone + base station Company Ticker Analyst comments exposure Analyst PMIC SG Micro 300661 CH - NR Non-rated SPE Chroma 2360 TT - N System level testers (semiconductor testers) for 5G RF/ PAs that do Jeff Ohlweiler compatibility testing, temperature (high/low extremes) and burn-in. Photonics tester for both VCSEL and EEL Advantest 6857 JP - OP Increasing demand for chip testers. The higher complexity of 5G SoCs will Damian Thong increase test times and drive need for chip tester upgrades in areas such as RF testing. Tokyo Electron 8035 JP - OP Benefits from investment in logic/foundry capacity for 5G devices and will see Damian Thong market share gains with the recovery of DRAM sector capex in support of the migration to LPDDR5 and DDR5 DRAM for 5G smartphones and datacentre infrastructure. Anritsu 6754 JP - NR Increasing demand for 5G chip testers. Non-rated Source: Company data, Macquarie Research, November 2019

Fig 16 Valuation multiples for Macquarie covered stocks 3M Stock Upsi Company Ticker Mkt cap ADTO Price performance TP (lcy) de Rec PE PB ROE Analyst (US$m) (US$m) (lcy) 1M 1Y 19E 20E 19E 20E 19E 20E

TSMC 2330 TT 254,704 291 299.00 8% 26% 350.00 17% O 22.8 18.2 5.2 4.7 21% 27% Patrick Liao Murata 6981 JP 37,800 202 5,863.00 11% -3% 6,500.00 11% O 45.3 20.3 2.3 2.1 14% 11% Hiroshi Taguchi Tokyo Electron 8035 JP 33,960 250 22,075 6% 42% 27,000 22% O 14.6 20.8 4.1 4.3 30% 20% Damian Thong MediaTek 2454 TT 21,151 110 405.00 5% 80% 310.00 -23% U 28.1 25.9 2.2 2.0 8% 8% Patrick Liao Largan 3008 TT 19,654 88 4,460.00 -1% 27% 5,000.00 12% O 20.8 17.8 4.7 4.0 25% 24% Cherry Ma LG Chem 051910 KS 18,939 48 309,000 5% -13% 400,000 29% O 33.8 13.2 1.3 1.3 4% 9% Anna Park Sunny Optical 2382 HK 18,107 103 129.40 9% 61% 163.56 26% O 37.5 24.3 10.5 7.7 32% 37% Cherry Ma Samsung SDI 006400 KS 13,888 46 231,000 7% 0% 360,000 56% O 27.0 11.9 1.3 1.2 5% 10% Daniel Kim TDK 6762 JP 12,813 89 10,830 8% 0% 12,800 18% O 16.7 16.3 1.6 1.5 10% 9% Hiroshi Taguchi ASEH 3711 TT 11,368 19 80.00 10% 28% 84.00 5% O 21.0 14.6 1.6 1.5 7% 10% Patrick Liao Advantest 6857 JP 9,460 143 4,945.00 6% 113% 6,400.00 29% O 17.2 25.5 4.9 4.5 35% 19% Damian Thong AAC 2018 HK 7,940 55 51.50 18% -23% 52.20 1% N 28.0 20.2 2.9 2.7 11% 14% Cherry Ma Shengyi 600183 CH 7,552 246 23.35 -6% 138% 28.11 20% O 35.6 26.6 6.9 6.1 21% 24% Erica Chen SEMCO 009150 KS 7,302 70 114,000 7% -16% 140,000 23% O 13.9 16.2 1.6 1.5 12% 9% Daniel Kim SCC 002916 CH 7,159 108 148.46 -2% 126% 156.50 5% N 43.4 32.3 10.7 8.5 28% 29% Erica Chen WUS 002463 CH 5,355 331 21.85 -11% 185% 22.65 4% N 32.2 26.4 7.4 6.3 26% 26% Erica Chen Win Semi 3105 TT 4,518 88 324.50 14% 194% 390.00 20% O 29.9 21.8 4.5 4.2 16% 20% Patrick Liao Zhen Ding 4958 TT 4,342 27 146.50 26% 106% 108.00 -26% N 14.1 13.5 2.0 1.8 15% 14% Kaylin Tsai JCET 600584 CH 4,271 145 18.75 9% 73% 22.50 20% O 4,081 2.5 2.5 -3% 0% Patrick Liao Taiyo Yuden 6976 JP 3,443 117 2,901.00 5% 10% 3,900.00 34% O 15.6 14.3 1.8 1.6 13% 12% Hiroshi Taguchi Chroma 2360 TT 1,961 10 143.00 -6% 15% 150.00 5% N 29.9 20.7 4.5 4.0 14% 21% Jeffrey Ohlweiler Inari INRI MK 1,539 5 1.99 3% 6% 1.35 -32% U 32.2 29.6 5.8 5.7 18% 19% Ben Shane Lim Q Tech 1478 HK 1,533 9 10.52 22% 149% 12.90 23% O 25.3 17.0 4.2 3.5 18% 22% Cherry Ma KYEC 2449 TT 1,518 19 37.80 8% 107% 40.00 6% O 16.0 12.3 1.8 1.7 11% 14% Patrick Liao Flexium 6269 TT 1,187 24 113.50 22% 38% 120.00 6% O 13.1 10.4 1.9 1.7 14% 17% Kaylin Tsai Kinsus 3189 TT 725 10 48.90 20% 14% 39.00 -20% N -11.6 112.4 0.9 0.9 -7% 1% Kaylin Tsai Source: Bloomberg, Company data, Macquarie Research, November 2019. Price as of Nov 1, 2019.

5 November 2019 9 Macquarie Research Global smartphones

Smartphone trend 2: camera upgrades • Camera upgrades are accelerating in 2H19. We surveyed a total of 132 smartphones launched in 2019 by the top six vendors – Samsung, Huawei, Apple, Oppo/Realme, vivo and Xiaomi. There are 489 cameras in total or an average of 3.7 cameras per device, with 1.0 front camera and 2.7 back cameras. About 45% of the 132 new devices adopted triple cameras, while quad camera penetration reached 18%.

Fig 17 Multi-cam penetration in back camera Fig 18 Number of lens set of by resolution

(lens set) 50% 100 supporting lens with Front or back main/ 45% special features secondary cameras 45% 90 40% 80 35% 70 60 30% 26% 50 25% 40 20% 18% 30 15% 11% 20 10% 10 5% 0 0% Camera resolution of new smartphones (2019 YTD) Single Dual Triple Quad TOF 2MP 5MP 8MP 10MP 12MP 13MP 16MP Back camera 20MP 24MP 25MP 32MP 40MP 48MP 64MP 108MP Source: Macquarie Research, GSMArena, November 2019 Source: Macquarie Research, GSMArena, November 2019

• In 2019/2020/2021E, we forecast the number of lens set per smartphone will reach 2.9/3.3/3.8 units and the total market size will increase to 4.10bn/4.85bn/5.62bn sets. We forecast overall triple camera penetration will reach 18%/34%/45%, while quad camera upgrades will happen in parallel with 1%/6%/16% during the period.

• We forecast smartphone camera content upgrade will drive industry value growth from our estimate of US$23.5bn in 2019 to US$45.4bn by 2023E.

Fig 19 Multi-cam penetration in back camera Fig 20 Number of lens set of by resolution

(units per (m units) 3.8 6,000 phone) 4.0 100% 3.3 3.5 90% 5,000 2.9 80% 3.0 2.4 70% 4,000 2.2 2.1 2.5 60% 3,000 2.0 50% 45% 40% 1.5 34% 2,000 30% 1.0 20% 1,000 18% 16% 0.5 10% 6% 0 - 0% 1% 1% 2016 2017 2018 2019E 2020E 2021E 2016 2017 2018 2019E 2020E 2021E Single Dual Triple Total lens demand Camera per phone Quad Other

Source: Macquarie Research, GSMArena, November 2019 Source: Macquarie Research, GSMArena, November 2019

Camera top buys: • Largan (3008 TT): robust demand for spec upgrade in the Android market driving ASP growth. • SEMCO (009150 KS): benefiting from the multi-camera trend and spec upgrade • Sony (6758): multi-camera trend to drive strong demand for Sony’s CMOS sensors • Sunny Optical (2382 HK): overall benefiting from the multi-camera trend with stabilising camera module gross margin; overall gross margin increasing through improving product mix of handset lens

• Q Tech (1478 HK): hot on O-Film’s heels and gaining share in the high-end segment 5 November 2019 10 Macquarie Research Global smartphones

Smartphone recovery driven by 5G In this report, we discuss historical trends and base our smartphone forecast on Gartner’s data. There has been wider divergence between Gartner and IDC’s smartphone shipment volumes since 2017 with 5%, 11% and 15% difference in 2017, 2018 and 1H19. Most of these differences occur in Asia ex-Japan and Europe. We believe these differences could be due to Gartner’s ability to track white-box smartphone shipments with its upstream semiconductor data resources.

Declining growth in smartphone demand on lengthening replacement cycle Global mobile phone shipments declined by 1.6% in 2018, reaching 1.8bn units. Smartphone shipment penetration reached 86% global shipment volumes in 2018, while feature phones volumes declined to 14%. Feature phone migration to smartphone is still ongoing in emerging markets. Most of the feature phone demand comes from India, Emerging Asia (ex-China, India) and the Middle East and Africa, where average smartphone adoption of 73% in the aforesaid regions in 1H19 is still below the global average of 86%.

Fig 21 Global mobile phone shipment (2011-19E) Fig 22 Feature and smartphone shipment mix (2011-19E)

(m units) (m units) 2,000 6% 100% 1,800 90% 4% 29% 1,600 80% 43% 1,400 70% 56% 2% 66% 74% 1,200 60% 79% 83% 86% 88% 1,000 0% 50% 800 40% 71% -2% 600 30% 57% 44% 400 20% -4% 34% 10% 26% 21% 200 17% 14% 12% 0 -6% 0% 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2011 2012 2013 2014 2015 2016 2017 2018 2019E

Feature Smartphone YoY Feature Smartphone \ Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Smartphone shipment growth has been slowing down from 22% five years ago in 2014 to 1.2% in 2018. In 1H19, smartphone volumes declined by -2.2% YoY to 741m units. The slowing demand is driven by the lengthening replacement cycle from 2.3 years in 2014 to about 3.3 years in 2019, mainly due to improving technology and maturing 4G penetration.

Fig 23 Global smartphone phone shipment (2011-19E) Fig 24 4G smartphone shipment (2011-19E)

(m units) (years) (m units) 1,800 46% 50% 3.5 3.34 1,600 3.13 3.18 39% 1,600 2.95 1,400 40% 3.0 1,400 2.67 1,200 1,200 30% 1,000 22% 2.5 2.30 1,000 2.1 800 14.4% 20% 2.0 800 1.9 2.0 600 600 5.1% 10% 2.7% 1.2% 400 400 -1.7% 1.5 0% 200 200 1.0 0 0 -10% 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2011 2012 2013 2014 2015 2016 2017 2018 2019E

4G smartphone shipment (RHS) Smartphone replacement Smartphone YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 11 Macquarie Research Global smartphones

5G smartphones to stimulate replacement demand We believe 5G smartphones will create a wave of replacement demands in the coming five years. The following figures show smartphone shipment and forecast by 3G, 4G and 5G technology cycle. The 3G smartphone shipment cycle took around eight years to reach its volume peak. We expect 4G smartphone shipment cycle to behave similarly, peaking in 2019 at 1.44bn units. In 2019, 5G smartphones have been launched by Android brands such as Samsung, Huawei, Oppo, Vivo, Xiaomi, OnePlus, ZTE and in selected markets. The ASPs of most 5G smartphones sold this year are in the premium range of above US$800/€730, but Vivo and Xiaomi are also offering 5G smartphones starting at about US$525/€480. We expect total 5G smartphone volumes to reach 19m in 2019.

Fig 25 Smartphone shipment by 3G/4G/5G technology Fig 26 Smartphone shipment by 3G/4G/5G technology

(m units) (m units) 1,600 1,800 1,400 1,600 1,200 1,400 1,000 1,200 1,000 800 800 600 600 400 400 200 200 0 0

3G 4G 5G 3G 4G 5G

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5G smartphone adoption to be quicker than 4G Adoption will be driven by four factors:

• Better specs sell phones, but consumers care about very few specs upgrades. The past three years have proved that better cameras sell phones, whereas large cost increases for limited functionality, eg, facial recognition, had limited success. Speed upgrades, ie what 5G delivers into phones, in our opinion are a no-brainer.

• Affordability will remain equivalent, at least in our opinion, as phones will only be 7% more expensive in 2020 and 3% by 2023. ARPUs should also increase mildly, if at all.

• Cost decline will be steep – as usual, this means component stocks should be good investments for the first 2-3 years, till late 2021. The mass market is never that profitable. As Qualcomm integrates 5G modems into its new 6- and 7- series chipsets and MediaTek releases integrated 5G SoC in early 2020, the cost of SoC silicon should decline, and we expect 5G smartphone shipments to accelerate, reaching 230m/584m/860m units in 2020/21/22E, driven by 5G adoption into mid-range smartphones. The rate of 5G smartphone penetration could be faster than 4G due to readiness of the chipset vendors as well as the higher market share concentration of the top vendors compared to five years ago.

• In the consumer market, telcos will remain pipelines: they cannot be behind competition on 5G roll-out because 5G will drive down data cost and lead to high-ARPU user churn. We have seen this with 4G, hence we expect telecom 5G capex to be sufficient to support our 5G smartphone sales forecasts.

5 November 2019 12 Macquarie Research Global smartphones

Fig 27 Global telecom radio access 5G capex Fig 28 Global 5G base stations deployments

(US$bn) (k units) 50 1,600

45 1,400 40 1,200 7 35 200 1,000 520 850 1,000 30 850 630 660 850 850 25 800 570 20 600 15 550 400 370 10 380 520 300 480 480 200 480 480 5 200 160 170 120 90 0 - 60 - - 2011 2013 2015 2017 2019E 2021E 2023E 2025E 2017 2018 2019 2020 2021 2022 2023 2024 2025

2G 3G 4G 5G 2G 3G 4G 5G

Source: Macquarie Research, Company Data, November 2019 Source: Macquarie Research, Company Data, November 2019

We forecast smartphone demand in 2019 will decline by 1.7% prior to 5G network readiness and volume demand to recover by 0.5%, 2.6% and 4.0% to 1.53bn, 1.58bn and 1.64bn units in 2020, 2021 and 2022E, respectively, on 4G to 5G upgrade.

5G smartphone adoption by country We expect 5G demand in China to kick start the global 4G to 5G upgrade cycle with 107m and 326m units in 2020 and 2021E, respectively, accounting for over 50% of global 5G smartphone volumes. We forecast 5G smartphones will be fully penetrated in China by 2022E. In developed markets, we forecast 5G smartphone adoption will reach over 80% by 2023E, while emerging market penetration should lag by about two years.

Fig 29 5G smartphones shipment by region (2019-24E) (m units) 2019E 2020E 2021E 2022E 2023E 2024E

North America 3 35 60 100 140 160 Europe 3 25 45 120 165 175 Mature Asia 10 30 50 65 80 80 China 3 108 339 415 437 427 India 0 2 20 25 50 100 Emerging Asia (ex-China ex-India) 0 5 20 45 130 150 Latin America 0 10 25 45 65 95 Eurasia 0 5 5 15 25 35 MEA 0 10 20 30 60 72 5G smartphone vol 19 230 584 860 1,152 1,294 YoY 1112% 154% 47% 34% 12% 5G mix of total smartphones 1.2% 15% 37% 52% 68% 76% Total smartphone vol 1,529 1,537 1,577 1,640 1,682 1,693 YoY -1.7% 0.5% 2.6% 4.0% 2.6% 0.6% Source: Macquarie Research, November 2019

5 November 2019 13 Macquarie Research Global smartphones

Fig 30 5G smartphone penetration by region (2019-24E)

100%

80%

60%

40%

20%

0% North Europe Mature China India Emerging Latin Eurasia MEA America Asia Asia ex America 2019E 2020E 2021E 2022E 2023E 2024E

Source: Macquarie Research, November 2019

Increasing smartphone ASP Per Gartner, smartphone ASP has been steadily rising, from US$245 in 2016 to US$287 in 2018 and our estimate of US$302 in 2019, driven by the increasing ASPs in the emerging markets. Overall demand for entry-level smartphones has being declining, as consumers in emerging markets have been trading up their entry level devices with mid-range or high-end smartphones for better specs including better camera, larger display and longer battery life. This trend is particularly noticeable in India and Emerging Asia (ex-China, India), where smartphone ASP increased by 52% and 38%, respectively, in 2018 compared to 2016.

Fig 31 Global smartphone ASP Fig 32 Smartphone ASP by region

(US$) (US$) 330 350 310 300 290 250 270 R² = 0.2969 250 200 230 150 210 100 190 50 170 150

China India Emerging Asia ex Blended ASP Linear (Blended ASP) Latin America Eurasia MEA Blended ASP

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Demand by region In 1H19, China accounted for 27% of global smartphone demand, followed by Emerging Asia (ex- China, India) 14%, Europe 12%, North America 10%, Middle East and Africa 11%, India 9%, Latam 9%, Mature Asia 5% and Eurasia (Russia, Ukraine and Middle Asia) 3%. Smartphone volumes in 1H19 declined by -2.2%, but emerging markets still saw decent growth in Latam and Emerging Asia, with volumes increasing by 10.4% and 2.9% YoY. Regions with worse than average declines were North America (-13.7%), Mature Asia (-8.7%), Eurasia (-5.8%) and Europe (-3.1%). China saw a 1.4% YoY decline in 1H19, of which 1Q19 was worse at a 3.2% decline but recovered in 2Q19 to a 0.5% increase.

5 November 2019 14 Macquarie Research Global smartphones

Fig 33 1H19 smartphone demand by region

Mature Asia Eurasia 3% Central & Latin 5% America 9% China 27%

India 9%

Emerging Asia MEA (ex-China ex- 11% India) North 14% America 10% Europe 12%

Source: Gartner, Macquarie Research, November 2019

Smartphone forecast by region We forecast an overall recovery starting 2H20E, driven by the 5G replacement cycle. We expect China smartphones to decline by 3% in 1H20, followed by a 2% YoY recovery in 2H20, 3% growth in 2021E and 5% growth in 2022E. The rest of the regions are discussed in the following and appendices sections.

Fig 34 Smartphone volumes and forecasts by region (2014-24E) Smartphone volume by region (m units) 2014 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

North America 175 184 180 187 174 153 152 155 160 163 166 Europe 145 188 194 198 194 189 189 190 194 196 192 Mature Asia 85 94 84 84 83 78 78 80 84 84 82 China 425 416 450 419 406 397 395 407 427 438 427 India 83 107 121 135 151 152 155 161 169 178 187 Emerging Asia (ex- 88 113 142 176 206 213 217 223 232 239 246 China ex-India) Latin America 133 153 134 130 128 137 138 143 150 156 159 Eurasia 66 43 51 50 49 46 46 46 46 46 46 MEA 111 125 139 158 164 163 166 171 177 182 187 Total 1,311 1,424 1,496 1,537 1,555 1,529 1,537 1,577 1,640 1,682 1,693

YoY North America 22% 5% -2% 4% -7% -12% 0% 2% 3% 2% 1% Europe 7% 30% 3% 2% -2% -3% 0% 1% 2% 1% -2% Mature Asia 5% 11% -11% 0% -2% -5% 0% 2% 5% 0% -2% China 20% -2% 8% -7% -3% -2% -1% 3% 5% 3% -3% India 89% 29% 13% 12% 12% 1% 2% 4% 5% 5% 5% Emerging Asia (ex- 73% 28% 26% 24% 17% 3% 2% 3% 4% 3% 3% China ex-India) Latin America 32% 15% -12% -3% -1% 7% 1% 3% 5% 4% 2% Eurasia 38% -35% 19% -2% -2% -5% -2% 0% 2% 0% 0% MEA 76% 13% 11% 14% 4% 0% 2% 3% 3% 3% 3% Total YoY 28.2% 8.6% 5.1% 2.7% 1.2% -1.7% 0.5% 2.6% 4.0% 2.6% 0.6% Source: Company data, Macquarie Research, November 2019

5 November 2019 15 Macquarie Research Global smartphones

China: a shrinking market but recovery in 2H20E Per Gartner, China smartphone shipments peaked in 2016 at 450m units, followed by two years of decline. We don’t expect a turnaround in 2019 yet. In 2Q19, CAICT and Gartner recorded 0.8% and 0.5% YoY shipment growth in China, but in 3Q19, CAICT tracked a 4.1% decline YoY. We expect another year of soft decline in China of -2.2% in 2019 and -3% in 1H20 due to the lengthening smartphone replacement cycle. We expect a +2% YoY recovery in 2H20, 3% growth in 2021E and 5% growth in 2022E, driven by 5G.

Fig 35 China smartphone shipment and growth (2012-18) Fig 36 China monthly shipment (2016 to Aug19)

(m units) (m units) 500 10% 70 40% 450 8% 8% 60 30% 400 6% 20% 350 5% 50 4% 10% 300 3% 3% 40 2% 2% 250 0% 0% 30 200 -1% -10% -2% 150 -2% -3% 20 -3% -20% 100 -4% 10 -30% 50 -6% -7% 0 -8% 0 -40% 2015 2016 2017 2018 2019E2020E 2021E 2022E2023E 2024E

China YoY China smartphones YoY (RHS)

Source: Gartner, Macquarie Research, November 2019 Source: CAICT, Macquarie Research, November 2019

Major share gain by Huawei The top four Chinese brands in total (Huawei, Oppo, Vivo and Xiaomi) continue to consolidate the market, gaining 5.7% share to 79% in 1H19. However, most of the consolidation in 2019 has been driven by Huawei, which has been consistently gaining +5% market share per year in the past two years. In 1H19, Huawei gained +8.2% market share, with volumes increasing by 31% YoY, despite a contracting market, driven by channel strategies in low-tier cities and, to a certain degree, nationalisation due to China-US trade tension. For other brands, Vivo was able to fortify its market share at 17.5%, but Oppo and Xiaomi lost -1.5% and -1.8% market share. Apple and Samsung’s market share continued to decline, by -0.5% and -0.4% to 7.8% and 1.3% in 1H19.

Fig 37 China smartphone market share by top 6 brands Fig 38 Top 6 smartphone vendors in China

Market share 1H18 1H19 +/- Huawei 23.8% 32.0% 8.2% 100% 2Q19, 81% 100% 90% 90% Oppo 19.2% 17.7% -1.5% 80% 80% Vivo 16.7% 17.5% 0.8% 70% 70% Xiaomi 13.2% 11.4% -1.8% 60% 60% Apple 8.3% 7.8% -0.5% 50% 50% Samsung 1.7% 1.3% -0.4% 40% 40% Top 4 in China 73% 79% 5.7% 30% 30% Top 6 in China 83% 88% 4.9% 20% 20% Volumes (m units) 10% 10% Huawei 49 64 31% 0% 0% Oppo 40 36 -10% Vivo 34 35 2.3% Xiaomi 27 23 -15% Huawei Oppo Vivo Xiaomi Apple 17 16 -7.8% Apple Samsung Samsung 3 3 -23% Others Top 4 in China (RHS) China 202 200 -1.4%

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 16 Macquarie Research Global smartphones

India India had the lowest smartphone penetration rate globally of 65% in 2018 and 67% in 1H19, below the global average of 86% and 87% in both periods. In 1H19, smartphone shipments in India reached 70.2m units, declining by 2% YoY. We forecast India smartphone demand to recover by 2%, 4% and 5% in 2020, 2021 and 2022E, respectively.

Fig 39 India smartphone penetration Fig 40 India smartphone shipment volume and growth

(m units) 100% 200 50% 87% 90% 83% 86% 180 45% 79% 43% 74% 160 40% 80% 71% 67% 70% 65% 140 35% 59% 120 30% 60% 56% 48% 100 25% 50% 43% 39% 80 20% 40% 30% 60 15% 30% 13% 12% 12% 18% 40 10% 20% 8% 20 4% 5% 5% 5% 5% 2% 10% 0 1% 0% 0% 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E 2012 2013 2014 2015 2016 2017 2018 1H19 India Global average smartphone penetration India YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Market share consolidation by top 5 brands in India The top four brands in India – Xiaomi, Samsung, vivo and Oppo – in aggregate accounted for a 69.3% market share in 1H19, increasing by 9.7% YoY, at the expense of the shrinking scale of local brands such as Micromax and Lava. Xiaomi has maintained its number one position for the past seven consecutive quarters, achieving a record-high market share of 27.6% in 2Q19. Per IDC, Xiaomi is maintaining its online sales channel dominance, with over 45% market share, and also increasing its sales offline retail channel exposure, which accounted for nearly 40% of its 2Q19 shipments. Samsung’s market share rebounded significantly in 1H19, gaining a 3.8% share with a 17% volume increase, driven by the Galaxy M series and its wide range of Galaxy A series across the low to mid-range segments. Vivo is the top market share gainer among the top four in 1H19 with a 4.4% share gain and 59.4% volume growth. Oppo ranks number four with a 0.9% share gain and 9.1% volume growth in 1H19. Per IDC, Realme (independent brand originating from Oppo) gained a 6% market share with shipment reaching 4.7m units up by over 11x, driven by online retailers and expanding offline channels.

Fig 41 India smartphone market share by top 10 brands Fig 42 Top 6 smartphone vendors in India

Market share 1H18 1H19 +/- Xiaomi 26.0% 26.5% 0.5% 100% 90% Samsung 19.2% 23.0% 3.8% 80% Vivo 6.9% 11.3% 4.4% 70% OPPO 7.5% 8.4% 0.9% 60% Realme 0.6% 6.7% 6.1% 50% Micromax 5.5% 4.1% -1.4% 40% Top 4 in India 59.6% 69.3% 9.7% 30% Top 6 in India 67.8% 75.9% 8.1% 20% Volumes (m units) 10% Xiaomi 18.7 18.6 -0.5% 0% Samsung 13.8 16.2 17.1% Vivo 5.0 8.0 59.4% Xiaomi Samsung Vivo OPPO 5.4 5.9 9.1% OPPO Realme Micromax Realme 0.4 4.7 1075.0% Huawei Apple Lava International Tecno Telecom Others Micromax 3.9 2.9 -26.6% India 72.0 70.2 -2.4%

Source: Gartner, IDC, Macquarie Research, November 2019 Source: Gartner, IDC, Macquarie Research, November 2019

5 November 2019 17 Macquarie Research Global smartphones

Emerging Asia Pacific (ex-China, India) Smartphone penetration in the Asia Pacific ex-China/India region is still below the global average at 78%. However, smartphone volume growth decelerated from 17% in 2018 to 2.9% in 1H19, as smartphone penetration slows down. We expect smartphone volume demand to increase by 2%/3%/4% in 2020/21/22E, with 5G volumes to start picking up in 2021-22E.

Fig 43 Asia ex-China, India smartphone penetration Fig 44 Asia ex-China, India smartphone volume and growth

(m units) 100% 250 50% 87% 90% 83% 86% 225 45% 79% 79% 78% 42% 80% 74% 72% 200 40% 66% 70% 64% 175 35% 56% 60% 53% 150 30% 50% 43% 125 26% 25% 39% 24% 40% 100 20% 17% 30% 22% 75 15% 20% 13% 50 10% 10% 25 4% 5% 3% 2% 3% 3% 3% 0% 0 0% 2012 2013 2014 2015 2016 2017 2018 1H19 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

Emerging Asia Global average smartphone penetration Emerging Asia (ex-China ex-India) YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

A chunky white-box market in Asia Pacific ex-China/India Per Gartner, about 30-40% of the Asia Pacific ex-China/India market is dominated by “Other Phone Vendors” or white box. For market share comparison in the following figure, we have excluded white box in our total market size. The top four vendors commanded an 80% market share in 1H19, consolidating 6.5% share YoY. Samsung is still the leading brand in this region, despite losing market share to the Chinese brands since 2016. Xiaomi, Oppo, Vivo and Huawei in aggregate accounted for 62.3% share in 1H19, gaining 7.9% YoY at the expense of Samsung, Apple and other smaller brands. Oppo and Vivo in particular were the top share gainers with 38% and 48% volume growth in 1H19, respectively.

Fig 45 Asia Pacific ex-China, India smartphone market Fig 46 Top 6 smartphone brands in Asia ex-China, India share (excluding white box)

Market share 1H18 1H19 +/- 100% Samsung 27.3% 24.6% -2.7% 90% Xiaomi 20.1% 18.1% -2.0% 80% Oppo 14.7% 20.4% 5.7% 70% Vivo 11.3% 16.8% 5.5% 60% Huawei 8.3% 7.0% -1.3% 50% Apple 3.3% 2.3% -1.0% 40% Top 4 Asia ex-China, India 73.4% 79.9% 6.5% 30% Top 6 Asia ex-China, India 85.0% 89.1% 4.1% 20% Volumes (m units) 10% 0% Samsung 18.0 16.1 -10.6% Xiaomi 13.3 11.9 -10.7% OPPO 9.7 13.4 38.1% Vivo 7.4 11.0 48.0% Samsung Xiaomi OPPO Vivo Huawei Apple Huawei 5.5 4.6 -16.4% Nexian Coolpad Wiko Lenovo Others Apple 2.2 1.5 -31.4% Asia ex-China, India 99.3 102.2 2.9%

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

The rest of the regions are discussed in the Appendices.

5 November 2019 18 Macquarie Research Global smartphones

Volume recovery benefits top six brands

Market share consolidation The smartphone market consolidation began in 2016 when global demand slowed down significantly from double digit to single digit growth. The top six brands (Samsung, Huawei, Apple, Xiaomi, Oppo and Vivo) are the consolidators, commanding a 70% market share in 1H19, up 3% YoY, with strong regional and global presence. We have sorted smartphone brands into three buckets:

• Consolidators: gaining market share globally/regionally with strong volumes from home base • Regional/Marginalised: market specific brands with stable volumes but facing threats by competition

• Losers. Local or global brands with declining scales across markets

Fig 47 The Consolidators, Regional/Marginalised Players and the Losers Consolidators Regional/Marginalised Losers

Samsung Lenovo / Motorola Asus Lava International Huawei LG Electronics Blackberry Meizu Apple TCL Communication Coolpad Micromax Xiaomi Tecno Telecom Gionee Sharp OPPO Wiko HTC Sony Vivo Karbonn Mobiles Spice Mobility Kyocera ZTE Others Source: Macquarie Research, November 2019

Fig 48 Smartphone brands consolidation

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18 3Q18 1Q19

Consolidators Regional / marginalized Losers

Source: Company data, Macquarie Research, November 2019

Chinese brands branching out with sub-brands While the Consolidators are gaining shares globally, the Chinese brands specifically are enlarging their footprint through sub-brands or spun-off brands.

• Huawei: Huawei’s main brand has a wide range of prices from US$110 to US$900 through the Mate, P, nova, Changwan and Maimang series, which are mainly sold through offline channels. Huawei Honor is a mid-range brand that has a tighter price range of US$100 to US$410, mainly targeting the online audiences.

• Oppo: The Oppo brand covers a price range of US$180 to US$610 through the Find, Reno, R, A, and K series, with over 60% of volumes coming from China and 10% from India. The Realme brand started off as a sub-brand of Oppo and became an independent company in 2018. Realme first focused on the Indian market as a value-for-money phone for youth with an attractive price range of US$85 to US$230. Realme expanded to Europe in 2019. 5 November 2019 19 Macquarie Research Global smartphones

• Vivo: The Vivo brand covers a price range of US$100 to US$410 through the NEX, X, S, Z, Y and U series, with 65% of volumes from China and 15% from India. The iQoo sub-brand targets smartphone gamers.

• Xiaomi: Both the Xiaomi and Redmi brand now cover the full price range from low-end to high- end. The Blackshark is for gamers, Meitu for beautifying photography, while Poco is an overseas only high-end brand.

Fig 49 Price range of Chinese smartphone brands

(US$) 1,000 900 800 700 600 500 400 300 200 100 -

Source: Company data, Macquarie Research, November 2019

The market share of the top four Chinese brands (Huawei, Oppo, Vivo and Xiaomi) in aggregate reached 40% in 2Q19, up from 36% in 2Q18 and 29% in 2Q17, driven mainly by Huawei’s share gain domestically and overseas expansion of the four brands.

Fig 50 Huawei, Oppo, Vivo, Xiaomi smartphone volume and market share

(m units) 160 45% 140 40% 120 35% 30% 100 25% 80 20% 60 15% 40 10% 20 5% 0 0%

HOVX HOVX share (RHS)

Source: Gartner, Macquarie Research, November 2019

Huawei With the US trade ban cutting off access to Google Mobile Services since May 2019, Huawei’s overseas smartphone sales would have to rely primarily on the platforms certified by Google before May, such as the P30 series, Y series, Honor 20, Nova 5T and legacy flagships (Mate 20 and P20). Prior to the trade ban, Huawei had been aggressively expanding in selected overseas markets. Huawei’s top three markets outside of China are Europe, Latam, and Middle East and Africa, representing 18%, 8.8% and 8.1% of shipment volumes in 1H19. Within two years’ time (1Q17 to 1Q19), Huawei’s market share in these regions has increased from 10% to 24% in Europe, 9% to 16% in Latam and 7% to 14% in MEA. 5 November 2019 20 Macquarie Research Global smartphones

Fig 51 Huawei smartphone volume mix by region Fig 52 Market share trend in Huawei’s key markets

100% 40% 90% 7% 35% 35% 8% 8% 9% 6% 10% 9% 80% 5% 9% 8% 10% 8% 8% 30% 8% 8% 6% 7% 8% 8% 9% 70% 18% 16% 15% 14% 17% 17% 17% 25% 60% 20% 20% 19% 21% 50% 20% 40% 15% 14% 30% 58% 57% 60% 61% 10% 10% 54% 54% 54% 50% 49% 50% 20% 5% 10% 0% 0% 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19

China Europe LatAm MEA Emerging Asia Mature Asia Others China Europe LatAm MEA

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Fig 53 Huawei smartphone shipment by region (1Q18-2Q19) Shipment Mix QoQ YoY 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 1Q 2Q 1Q 2Q 1Q 2Q China 21.9 26.9 26.1 29.5 29.1 35.2 50% 61% -1% 21% 33% 31% Overseas 18.5 22.9 26.1 30.9 29.4 22.9 50% 39% -5% -22% 59% 0% - Europe 6.9 8.5 10.5 12.3 11.4 9.2 19% 16% -8% -20% 64% 8% - Latam 2.5 3.3 4.2 4.9 5.4 4.9 9% 8% 10% -9% 118% 47% - MEA 3.5 4.2 5.1 5.9 5.5 3.9 9% 7% -7% -30% 58% -8% - Emerging Asia 3.2 4.2 3.4 4.4 3.9 2.4 7% 4% -11% -38% 22% -42% - Mature Asia 1.2 1.3 1.4 1.5 1.4 1.3 2% 2% -5% -8% 17% 2% - Others 1.1 1.4 1.5 1.8 1.7 1.2 3% 2% -7% -29% 46% -13% Total 40.4 49.9 52.2 60.4 58.4 58.1 100% 100% -3% -1% 45% 16% Source: Gartner, Macquarie Research, November 2019

Huawei in Europe (EU) Huawei’s shipment volume in Europe witnessed a CAGR of 27% over 2015 to 2018, with a solid market share increase from 6% in 2015 to 23% in 1H19, at the expense of Samsung and Apple but mainly smaller players. In 1Q19, Huawei’s shipments in Europe increased by 64 % YoY, but 2Q19 growth slid to 8%. While Huawei can continue selling smartphones certified by Google prior to May 2019, if the trade ban persists into 2020, we believe Huawei’s sales in Europe will be significantly hindered due to a lack of flagship refresh. We estimate the flagship accounts for 40-50% of Huawei’s Europe volume sales. We believe the closest rival to benefit from Huawei’s potential market share loss would be Samsung due to distribution channel overlap and brand equity, but not Apple due to the low iOS market share in the region and the large price gaps between the product lines. Xiaomi might also potentially benefit, but we expect share gains would be slower than Samsung due to the smaller distribution network.

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Fig 54 Smartphone market share in Europe (2015 v 1H19) Fig 55 Smartphone ASP in Europe by top brand

(US$) (US$) 40% 38% 400 1,000 34% 35% 900 350 800 30% 700 25% 23% 23% 300 19% 600 20% 16% 250 500 15% 13% 400 200 10% 6% 300 4.5% 4% 3% 3%2% 3% 200 5% 2% 1% 2%1% 1% 1% 150 0% 0% 100 0% 100 - 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18 3Q18 1Q19

Samsung Huawei Xiaomi 2015 1H19 Wiko Apple (RHS)

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Huawei in Latin America Latam is Huawei’s second-largest overseas market, accounting for 8.8% of total volumes in 1H19. Huawei’s shipment in Latam witnessed a CAGR of 21% over 2015 to 2018, with market share increasing from 5.5% in 2015 to 15% in 1H19. In 1Q19, Huawei’s shipments in Latam grew by 118% YoY, followed by another strong quarter of 47% YoY growth in 2Q19. The trade ban seems to have less impact on Latam demand compared to Europe, as Latam is a mid-ranger market with ASP of US$212 in 2018 compared to global average of US$286. Comparing market share and ASP by top brands, Huawei’s closest competitors are Samsung and Lenovo/Motorola.

Fig 56 Smartphone market share in Latam (2015 v 1H19) Fig 57 Smartphone ASP in Latam by top brands

(US$) 300 35% 31% 30% 26% 250 25% 200 18% 20% 17% 15% 15% 12% 150 10% 11% 10% 10% 7% 8% 6% 7% 7% 100 4%4% 5% 2% 2% 1% 2% 1% 0% 50 0%

Samsung Lenovo Huawei

2015 1H19 LG TCL Latam

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Huawei in Middle East and Africa Huawei’s shipments in MEA witnessed a CAGR of 12% over 2015 to 2018, with market share staying relatively flattish at 11-12% (with an exception of a dip in 2017 at 7%). Samsung’s market share in MEA is still unrivalled at 38% in 1H19. Tecno, an emerging market-focused brand, has been consistently gaining market share and now has similar scale as Huawei. As MEA is a mid- ranger market, we expect market share changes to be less sensitive to the trade ban.

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Fig 58 Smartphone market share in MEA (2015 v 1H19) Fig 59 Smartphone ASP in MEA by top brands

(US$) 50% 46% 350 45% 38% 300 40% 35% 250 30% 26% 200 25% 20% 150 15% 11%11%12% 10% 11% 100 10% 5% 5% 5% 4% 3.4%3% 3% 2% 50 5% 1% 1% 1% 1%1% 0%0% 1% 0% -

white-box Samsung Tecno

2015 1H19 Huawei MEA

Source: Company data, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Huawei in China Due to the overseas sales growth challenges inflicted by the trade ban, Huawei has redirected its resources on further expanding its channels and footprint in China. Huawei’s domestic market share has been increasing rapidly from 29% in 4Q18 to 35% in 2Q19. Shipment volumes in China in 1H19 increased by 31% YoY, despite an overall market decline of 1.4%. With Huawei increasing its focus on China, we believe the domestic market will be more competitive as ever. Huawei’s latest flagship, the Mate 30 series, is launched in China first before rolling out to rest of the regions. Richard Yu, CEO of the Consumer BG, expects the Mate 30 series will sell at least 20m units, despite the lack of Google apps and services.

Fig 60 Smartphone market share in China Fig 61 Huawei’s smartphone volume growth in China

(m units) 45% 40 60% 40% 35 50% 35% 30 30% 40% 25 25% 20% 20 30% 15% 15 20% 10% 10 5% 10% 5 0% 0 0%

Huawei OPPO Vivo Xiaomi Apple Samsung China YoY (RHS) Others

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Huawei shipment forecast Our Huawei shipment assumption factors in the effect of the US trade ban in the European markets, but we expect limited impact in the rest of the overseas market. We forecast demand recovery in 2021E.

• In the European market, we forecast Huawei’s share will decline from 20% in 2018 to 18% and 15% in 2019E and 2020E, recovering to 25% in 2021E.

• In the rest of the overseas market, we forecast Huawei’s share will be flat at 6% in 2019 and increase to 7% and 10% in 2020E and 2021E on competitive 5G smartphone offerings. Overall, we expect Huawei’s smartphone volume to reach 240m/254m/323m units in 2019E/ 2020E/2021E, representing global market share of 16%/17%/21%.

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Fig 62 Huawei smartphone shipment forecasts (m units) 2016 2017 2018 2019E 2020E 2021E

China 71 86 105 147 159 178 Europe 22 24 38 35 28 48 RoW 40 40 60 58 67 98 Total 133 151 203 240 254 323

Market share assumptions China 16% 21% 26% 35% 40% 45% Europe 11% 12% 20% 18% 15% 25% RoW 5% 4% 6% 6% 7% 10% Total 9% 10% 13% 16% 17% 21% Source: Gartner, Macquarie Research, November 2019

Other Chinese brands forecasts We expect China smartphone market competition to intensify this year with Huawei increasing its sales efforts domestically. We forecast Oppo, Vivo and Xiaomi’s domestic market share in aggregate will decline from 50% in 2018 to 47%/46%/43% in 2019/20/21E. We expect these brands to focus their resources overseas to grab market share on Huawei’s weakness. We forecast overseas market share for these brands in aggregate to increase from 12% in 2018 to 15%/18%/22% in 2019/20/21E.

Fig 63 Smartphone forecasts for Oppo, Vivo and Xiaomi (m units) 2016 2017 2018 2019E 2020E 2021E

Oppo China 69 84 81 71 67 65 Overseas 16 28 38 48 57 70 Total 85 112 119 119 124 135

Vivo China 63 76 72 71 75 69 Overseas 10 23 30 45 57 70 Total 72 100 102 117 132 139

Xiaomi China 52 57 50 42 39 41 Overseas 9 32 73 79 91 111 Total 61 89 122 121 131 152 Source: Gartner, Macquarie Research, November 2019

Fig 64 Huawei, Oppo, Vivo, Xiaomi market share in China Fig 65 Huawei, Xiaomi, Oppo, Vivo market share Overseas

100% 40%

90% 35% 10% 10% 80% 11% 30% 6% 70% 12% 14% 19% 17% 18% 25% 60% 5% 6% 18% 4% 50% 12% 18% 16% 20% 18% 17% 3% 5% 40% 3% 4% 10% 14% 14% 20% 15% 30% 20% 2% 6% 7% 8% 8% 10% 20% 15% 44% 1% 3% 8% 37% 40% 2% 1% 3% 12% 26% 5% 1% 10% 16% 21% 9% 8% 8% 14% 5% 6% 6% 0% 0% 2015 2016 2017 2018 2019E 2020E 2021E 2015 2016 2017 2018 2019E 2020E 2021E

Huawei Oppo Vivo Xiaomi Huawei Xiaomi Oppo Vivo

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

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Samsung Samsung is likely to grow its smartphone shipments in 2020 by over 8%YoY, the highest since 2013. This is due largely to the muted competition in Europe (from Huawei troubles) and the rising 5G phone market. Its 5G phone should sell mainly in Korea, the US, and to a certain degree Japan, since 5G-ready iPhones will only become available in 4Q20. The company has a limited presence (1% share) in China, the major 5G phone market for the next three years. We see two swing factors to its smartphone growth and profitability: First, the company plans to grow ODM volume, mainly for low-end market such as India, in order to fend off rising competition from Chinese smartphone vendors such as Xiaomi and Oppo, and to shore up its profitability. Second, the company is pondering its foldable phone line-up in 2020, especially about pricing strategy.

Gainers get bigger We expect the top six consolidators to continue gaining market share, from 67% in 2018 to 71%/ 76%/82% over 2019/20/21E, at the expense of smaller/local brands.

Fig 66 Market share forecasts by top smartphone brand (m units) 2016 2017 2018 2019E 2020E 2021E

Samsung 309 317 291 303 327 348 Huawei 133 151 203 240 254 323 Apple 216 215 209 185 201 193 Xiaomi 61 89 122 121 131 152 OPPO 85 112 119 119 124 135 Vivo 72 100 102 117 132 139 Lenovo 52 47 39 40 39 39 LG Electronics 55 56 39 36 38 39 Others + WB 512 450 430 368 291 209 Total 1,496 1,537 1,555 1,529 1,537 1,577

Market share Top 6 59% 64% 67% 71% 76% 82% HOVX 24% 29% 35% 39% 42% 48% Source: Gartner, Macquarie Research, November 2019

Fig 67 Smartphone market share between gainers & losers Fig 68 Smartphone market share of the top six brands

100% 100% 9% 90% 15% 24% 21% 90% 18% 31% 26% 9% 24% 31% 33% 29% 80% 8% 80% 36% 8% 44% 41% 9% 70% 8% 9% 70% 8% 13% 10% 8% 9% 60% 8% 9% 60% 7% 8% 10% 7% 50% 3% 6% 6% 9% 50% 2% 5% 8% 40% 82% 5% 6% 8% 12% 76% 4% 13% 71% 12% 64% 67% 40% 13% 30% 56% 59% 16% 14% 14% 21% 20% 30% 17% 7% 9% 10% 13% 16% 10% 20%

0% 10% 23% 21% 21% 19% 20% 21% 22% 2015 2016 2017 2018 2019E 2020E 2021E 0% 2015 2016 2017 2018 2019E 2020E 2021E Consolidators Regional / marginalized Losers Samsung Huawei Apple Xiaomi Vivo Oppo Others

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

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Smartphone trend 1: 5G $ content in components Components with chunky bills of material growth in a 5G smartphone include the application processor, baseband, RF component and substrates, due to doubling the number of bands in a 5G smartphone (500 bands) compared to 4G (250 bands). Silicon content is expected to increase by 30-35% in a 5G smartphone compared to 4G. Smartphone with mmWave 5G capability is expected to have a higher cost compared to the Sub-6GHz version, due to more complex and integrated RF front-end design. Per Tech Insight’s estimate, there’s about US$65 incremental 5G component costs in the Samsung Galaxy S10+ Sub-6GHz 5G compared to the regular S10+.

• An additional US$32 for Samsung’s 5G baseband • A US$15 increase in RF component • A US$13.5 increase in substrates • A US$3 increase in power management and audio

• A US$1 increase in battery

Fig 69 Component costs comparison of Samsung’s Galaxy S10+ 5G vs regular version

(US$) 90 5G specific increase 80 70 60 +$15 50 40 +$32 +$13.5 30 20 +$1.0 +$3.0 10 0

Samsung Galaxy S10+ Samsung Galaxy S10+ 5G

Source: Tech Insight, Macquarie Research, November 2019

Fig 70 Samsung Galaxy S10+ Sub-6GHz 5G vs S10+ 4G Samsung Samsung Galaxy Extra items in 5G version Components cost (US$) Galaxy S10+ 5G S10+ 4G +/- that we identified

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5G implication by component • 5G SoC: We expect a 30-35% die size increase in 5G SoC compared to 4G. Huawei was the first to announce its integrated 5G SoC Kirin 990 5G, followed by Qualcomm and Mediatek. Except for Samsung, 5G chips are processed on TSMC’s 7nm+ and 5nm in 2020. Overall, like- for-like, we expect the application processor to get larger due to multiple high-resolution cameras and more bandwidth calculations. For the modem, it is simply the increase in number of bands and total bandwidth from 4G to 5G which leads to a very large 30-40% increase in modem size. Looking at Huawei Kirin 990 5G compared to Kirin 980 4G, the die size is 35% larger. The transistor counts for the 5G chip reached 10.3bn, over 2bn more compared to the Kirin 990 4G version.

Fig 71 Smartphone logic semi value and % of total

(US$bn) 80.0 20% 70.0 18% 60.0 16% 50.0 15% 15% 16% 40.0 14% 13% 13% 13% 14% 30.0 13% 12% 20.0 12% 10.0 0.0 10% 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E

Logic semi Logic semi % of smartphone value

Source: Macquarie Research, Gartner, November 2019

• Back-end testing and packaging time increases with more complex 5G chip design. Yole Development forecasts advanced packaging revenue to see a CAGR of 8% from about US$28bn in 2018 to US$46bn in 2024E.

• SPE makers including Advantest, Tokyo Electron, Anritsu and Chroma benefit from the logic foundry capex increase for expanding capacity for 5G demand and the back-end’s chip tester upgrades and increasing test times for 5G SoCs

• Passives: 5G smartphone will require small size and higher capacitance MLCC, benefiting top MLCC makers with technological advantages, including Murata, Semco and Taiyo Yuden.

• PCB/ Substrates: There’s increasing BT substrate demand from 5G RF IC and antenna components in the smartphone. For PCB on the base station, we estimate content value per 5G macro station will increase by 3x of 4G stations in the initial stage, driven by the use of upgraded materials and more precise manufacturing process to achieve high-speed and high- frequency features of 5G. For FPCB, 5G will bring more adoptions of modified PI and LCP. For HDI, it will trigger upgrades to any-layer HDI or even SLP, which is also positive for CCL manufacturers. Yole Development forecasts global advanced substrate revenue will see a CAGR of 8% from about US$7.9bn in 2018 to US$12.7bn in 2024E.

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Fig 72 Advanced packaging revenue forecast by platform Fig 73 Global advanced substrates revenue forecast

(US$bn) (US$bn) 50 20% 14 12.7 45 18% 12 40 16% CAGR +8% 35 14% 10 30 12% 7.9 25 10% 8

20 8% 6 15 6% 10 4% 4 5 2% 2 0 0% 2018 2019E 2020E 2021E 2022E 2023E 2024E 0 2018 2024 Fan-out Flip-chip Fan-in WLP

TSV Embedded due YoY growth Global advanced substrates revenue forecast

Source: Yole Development, Macquarie Research, November 2019 Source: Yole Development, Macquarie Research, November 2019

• Memory: migration to LPDDR5 mobile DRAM. • Antenna: Massive MIMO leads to increasing number of antennas in the base station and smartphones.

• RF device module: For both sub-6 and mmWave 5G, new RF technology will be required to manage higher frequency. Contents per smartphone will increase. The following table shows the RF content growth by generation. According to Skyworks, compared to 4G, the number of filters for 5G will increase from 40 to 70, the number of transceiver/ receiver filters to increase from 30 to 75, the number of carrier aggregation combinations increases by 20x to 200, etc.

Fig 74 Increasing front-end RF content by mobile generation Generation 2G 3G 4G 5G

Front-end value per phone US$3 US$8 US$18 US$25 Value growth by Gen 1.67x 1.25x 39% Front-end content PAs PAs Filters: 40 Filters: 70 Filter Bands: 15 Bands: 30 Switches Tx/Rx filters: 30 Tx/Rx filters: 75 Switch throws: 10 Switch throws: 30 CA combos: 10 CA combos: 200 Peak rate 150Mbps Peak rate > 1Gbps 2x2 MIMO DL 4x4 MIMO DL and UL Source: Skyworks, Macquarie Research, November 2019

• According to Yole Development, the total front-end RF module industry value is going to increase from US$15bn in 2017 to US$35bn in 2023, showing a CAGR of 14%. Filters’ industry value share is expected to increase from 54% in 2017 to 65% in 2023 and accounts for 73% of the total value increase.

• Beneficiaries: WinSemi, Murata, and Taiyo Yuden have potential to expand business, especially with Chinese smartphone makers.

• Broadcom’s single-source OSAT, INRI, could also be a major beneficiary of higher RF filter content, assuming Broadcom maintains its content share with Apple.

5 November 2019 28 Macquarie Research Global smartphones

Fig 75 RF front end industry value Fig 76 RF front-end industry value share

(US$m) (US$m) 25,000 US$15bn US$35bn 100% 90% 7% 20,000 9% 80% 20% 34% 15,000 70% 60%

10,000 50% 40% 5,000 30% 65% 54% 20% - 10% Filters PAs Switches Antenna LNAs mmW FEM tuners 0% 2017 2023

2017 2023 Filters PAs Switches Antenna tuners LNAs mmW FEM

Source: Yole Development, Macquarie Research, November 2019 Source: Yole Development, Macquarie Research, November 2019

According to IHS' analysis, the dollar content increase for RF front-end for the first generation of Sub-6GHz 5G smartphone is about US$10-11, or a 45-60% cost increase compared to its 4G components (RF transceiver to the antenna). The cost for Sub-6GHz + mmWave is about 2x higher than its 4G costs due to the increased complexity of mmWave RF design and integration. The following chart compares Samsung Galaxy S10+ 5G’s RF front-end dollar content (Sub-6GHz + mmWave) with other Sub-6GHz-only 5G Android brands to illustrate the massive cost increase for integrating mmWave 5G capability.

Fig 77 RF front-end cost increase for 5G

(US$) Sub-6GHz only Sub-6GHz + 90 mmWave 250% 80 70 200% 205% 60 150% 50 40 100% 30 59% 46% 48% 49% 20 50% 10 0 0% OnePlus LG V50 Oppo Xiaomi Samsung

Existing 4G cost 5G cost % increase in 5G RF front-end components (RHS)

Source: IHS, Macquarie Research, November 2019

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Smartphone trend 2: multi-camera upgrade The second key trend is the increasing dollar content of cameras in smartphones. We’ve surveyed a total of 132 smartphones launched in 2019 by the top six vendors (Samsung, Huawei, Apple, Oppo/Realme, vivo and Xiaomi) for component specs trend of cameras. Huawei has launched the highest number of SKUs, with 29 devices in our sample, followed by vivo and Xiaomi with 25 devices each. We have categorised the smartphones into four price segments: low-end (below €150), mid-range (between €150-300), high-end (between €300-450) and premium (above €450). Out of the 132 smartphones, we have 20% low-end, 42% mid-range, 14% high-end and 23% premium devices.

Fig 78 Number of new devices per brand Fig 79 Mix by price segment

35 30 25 23% 20% 20 15 10 5 14% 0 42%

New smartphones launched YTD Low-end Mid-range High-end Premium

Source: Macquarie Research, GSMArena, November Source: Macquarie Research, GSMArena, November 2019 2019

Resolution going up to 108MP but 2-8MP still a sizable market, positive for supply chain The path for resolution migration is clear, as brands are competing to sell the best camera phones. The main cameras of the flagship brands have been upgraded from 24MP to 48MP, while some leading designs feature 64MP and even 108MP cameras. We expect 64MP to become the main spec for next year’s flagship devices. However, the multi-cam set-up also requires 2-8MP supporting cameras, with special features such as telephoto, ultrawide angle, dedicated macro lens and depth sensing. 2-8MP resolution still represents 41% of total lens volume mix in our sample size. We believe resolution and spec migration as well as abundant demand for 2-8MP cameras will support the growth of leading vendors Largan in lenses and Sunny Optical in lenses and modules and mid-end players such as AAC in lenses and Q Tech in modules.

Fig 80 Front and back camera resolution mix Fig 81 Number of lens set of by resolution

108MP TOF (lens set) 2% 64MP 0% 100 supporting lens with Front or back main/ 1% 90 special features secondary cameras 40MP 80 48MP 1% 2MP 11% 70 16% 60 32MP 25MP 50 7% 1% 5MP 40 24MP 8% 1% 30 20MP 20 3% 16MP 10 13% 8MP 18% 0 Camera resolution of new smartphones (2019 YTD) 13MP 12MP 11% 7% TOF 2MP 5MP 8MP 10MP 12MP 13MP 16MP 10MP 20MP 24MP 25MP 32MP 40MP 48MP 64MP 108MP 1% Source: Macquarie Research, GSMArena, November 2019 Source: Macquarie Research, GSMArena, November 2019

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Front camera: water drop and pop-up design account for 77% of mix For the front camera, form factor wise, water drop appears to be the most popular design among all the Android brands, with over 50% overall adoption, followed by motorised pop-up (20%), hole punch (11%) and fringe (6%). Motorised pop-up front cameras are widely used by Oppo and Vivo with 47% and 32% adoption; there are 26 models out of 132 new devices using motorised pop-up design. Front camera resolution is also getting upgraded. About 27% of our sample size has a 16MP front camera, followed by 22% with 32MP cameras and 14% equal mixes for 20-25MP, 10- 13MP and 8MP.

Fig 82 Front camera form factor Fig 83 Front camera resolution

70% 5MP 60% 57% 9% 32MP 22% 50% 8MP 14% 40%

30% 20% 20-25MP 10-13MP 20% 14% 14% 11% 6% 10% 4% 2% 0% Water drop Pop up Hole punch Fringe Top panel Full screen 16MP no cam 27%

Front camera

Source: Macquarie Research, GSMArena, November 2019 Source: Macquarie Research, GSMArena, November 2019

Back camera: 63% of new devices use triple and quad cameras The year 2019 marks the beginning of triple- and quad-back camera adoption among major brands. Out of the 132 new smartphone models we’ve surveyed, there are 489 cameras in total or an average of 3.7 cameras per device, with 1.0 front camera and 2.7 back cameras. About 45% of the 132 new devices adopted triple camera, while quad camera also reached 18% penetration. There are still 26% and 11% of dual and single camera adoption for low-end and mid-range smartphones. In terms of specs, cameras with above 40-48MP resolution represent about 50% of the main camera; about 48% of the secondary cameras use 8MP resolution with ultrawide angle feature; about 66% of the third cameras have a 2-5MP dedicated macro lens or depth sensor; the fourth camera is entirely for depth-sensing purposes.

Fig 84 Back camera form factor Fig 85 Back camera resolution by lens

50% 100% 45% 4% 6% 2% 45% 90% 11% 19% 40% 80% 12% 35% 70% 46% 5% 30% 26% 60% 17% 81% 25% 50% 2% 48% 5% 20% 18% 40% 8% 30% 15% 11% 49% 10% 20% 30% 11% 10% 5% 15% 19% 0% 4% 0% Main 2nd 3rd 4th Single Dual Triple Quad TOF 2MP 5MP 8MP 10-13MP 16MP

Back camera 20-25MP 32MP 40-48MP 64MP 108MP

Source: Macquarie Research, GSMArena, November 2019 Source: Macquarie Research, GSMArena, November 2019

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Back camera form factor by top Android brand The following charts summarise multi-camera adoption by price segment of top Android brands.

• Samsung has lagged behind in camera design in the past but is catching up aggressively in 2019. Out of the 21 new devices we tracked, over 60%, or 13 devices, have triple cameras across the low-end to premium price segments. Samsung also launched quad cameras in its flagship Note 10+.

• Huawei is rolling out quad cameras from premium to mid-range devices this year. About 70% of Huawei’s high-end and premium models have quad cameras; about 58% of mid-range devices have triple cameras; but the majority of Huawei’s low-end offerings still use single 13MP cameras.

Fig 86 Samsung back camera Fig 87 Huawei and Honor back camera

100% 100% 14% 14% 8% 90% 25% 90% 80% 80% 50% 70% 70% 67% 60% 60% 58% 71% 50% 50% 100% 50% 40% 86% 40% 86% 30% 38% 30% 20% 20% 25% 33% 10% 25% 29% 13% 10% 0% 0% 8% Low-end Mid-range High-end Premium Low-end Mid-range High-end Premium

Single Dual Triple Quad Single Dual Triple Quad

Source: Macquarie Research, GSMArena, November Source: Macquarie Research, GSMArena, November 2019 2019

• Oppo is upgrading to quad cameras in premium to mid-range devices, although dual cameras are still over 50% of the 19 new smartphones we’ve tracked.

• Realme is an independent brand originated from Oppo, focusing on the low-end to mid-range market. Out of the 11 new devices we’ve tracked, five devices have quad cameras and six devices have dual cameras, which is very competitive compared to competitors’ offerings.

Fig 88 Oppo back camera Fig 89 Realme back camera

100% 100% 90% 90% 80% 33% 33% 40% 80% 33% 50% 70% 70% 60% 60% 60% 50% 50% 40% 40% 40% 30% 67% 67% 30% 67% 50% 20% 20% 40% 10% 20% 10% 0% 0% Low-end Mid-range High-end Premium Low-end Mid-range

Single Dual Triple Quad Dual Quad

Source: Macquarie Research, GSMArena, November Source: Macquarie Research, GSMArena, November 2019 2019

• Vivo has adopted triple camera across its low-end to premium smartphones, with over 80% penetration in our sample of 25 new devices.

• Xiaomi uses triple cameras across its high-end and premium smartphones, except for the gaming smartphone Black Shark, which houses a set of dual cameras instead. The Redmi Note 8 series (within the low-end and mid-range segment) uses quad-camera design with 48MP as the main camera. Xiaomi’s latest flagship, Mi Mix Alpha, sports a triple camera set-up with a 108MP lens.

5 November 2019 32 Macquarie Research Global smartphones

Fig 90 Vivo back camera Fig 91 Xiaomi and Redmi back camera

100% 100% 90% 14% 90% 14% 13% 80% 80% 50% 50% 70% 70% 60% 60% 43% 83% 63% 50% 100% 50% 100% 40% 86% 40% 30% 30% 50% 50% 20% 20% 43% 10% 17% 10% 25% 0% 0% Low-end Mid-range High-end Premium Low-end Mid-range High-end Premium Single Dual Triple Quad Single Dual Triple Quad

Source: Macquarie Research, GSMArena, November Source: Macquarie Research, GSMArena, November 2019 2019

Camera forecast We estimate the number of cameras per smartphone reached 2.4 units in 2018, driven by Huawei’s lead in triple-camera upgrade, as well as the overall increase in dual-camera adoption in major brands. We forecast triple-camera penetration will reach 18%/34%/45% over 2019/20/21E, while quad-camera upgrades should happen in parallel with 1%/6%/16%. Therefore, over 2019/20/21E, we forecast the number of lens set per smartphone will reach 2.9/3.3/3.8 units and the overall smartphone lens volume in the market will reach 4.1bn/4.85bn/5.63bn sets.

Fig 92 Smartphone camera forecasts

(m units) (units per phone) 6,000 3.8 4.0 3.3 3.5 5,000 2.9 3.0 4,000 2.4 2.1 2.2 2.5 3,000 2.0 1.5 2,000 1.0 1,000 0.5 0 - 2016 2017 2018 2019E 2020E 2021E

Total lens demand Camera per phone

Source: Company data, Macquarie Research, November 2019

5 November 2019 33 Macquarie Research Global smartphones

Fig 93 Smartphone back camera mix forecasts

100% 90% 80% 70% 60% 50% 45% 40% 34% 30% 20% 18% 16% 10% 6% 0% 1% 1% 2016 2017 2018 2019E 2020E 2021E

Single Dual Triple Quad Other

Source: Company data, Macquarie Research, November 2019

We estimate the industry value for smartphone camera to increase from US$23.5bn in 2019E to US$45bn by 2023E. Our calculation is based on our blended iPhone camera content estimate of US$40 and Android camera content estimate of US$12 in 2019, which would grow by a five-year CAGR of about 14% to average camera content of US$76 for the iPhone and US$20 for an Android smartphone on the increasing multi-cam adoption per phone.

Fig 94 Increasing Industry value for camera

(US$bn) 60 9.0% 48.6 8.0% 50 45.4 41.4 7.0% 40 37.1 6.0% 33.1 5.0% 30 23.5 21.3 22.8 4.0% 20 15.5 3.0% 12.9 2.0% 10 1.0% - 0.0% 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

Industry value - camera % of total smartphone value

Source: Macquarie Research, Gartner, November 2019

5 November 2019 34 Macquarie Research Global smartphones

Appendices • Appendix 1: Smartphone by region • Appendix 2: Fingerprint sensor adoption • Appendix 3: Supply chain tables

Appendix 1: Smartphone by region

Latin America Smartphone penetration in Latin America increased by 2ppts to 94% in 1H19, above the global average. Smartphone shipments in the past three years have declined by 12%/3%/1% but recovered in 1H19, growing by 10% YoY. We forecast smartphone demand to increase by 1%/3%/5% over 2020/21/22E, with 5G smartphone penetration to reach 7%/18%/30% over the same period.

Fig 95 Latin America smartphone penetration Fig 96 Latin America smartphone shipment and growth

(m units) 100% 94% 180 20% 89% 92% 88% 86% 87% 90% 85% 83% 160 79% 15% 15% 80% 74% 71%71% 140 70% 10% 120 7% 60% 56% 53% 5% 5% 100 4% 3% 50% 43% 2% 80 1% 0% 40% -1% 30% 60 -3% 30% -5% 40 20% -10% 20 10% -12% 0% 0 -15% 2012 2013 2014 2015 2016 2017 2018 1H19 2015 2016 2017 2018 2019E2020E 2021E2022E 2023E2024E

Latam Global average smartphone penetration Latin America YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Huawei gaining shares The top four smartphone brands in the Latam region capture 67% market share and top six brands 77%. Samsung and Lenovo (Motorola) have strong mind-share and are still the top two smartphone vendors, with 26% and 18% share in 1H19. However, in the past two years, Huawei has gained recognition, with market share catching up to 15% in 1H19.

Fig 97 Latin American smartphone market share Fig 98 Top 6 smartphone vendors in Latin American

Market share 1H18 1H19 +/- Samsung 28.8% 26.4% -2.4% 100% 90% Lenovo (Motorola) 18.2% 18.0% -0.2% 80% Huawei 9.5% 15.3% 5.8% 70% LG Electronics 8.8% 6.8% -2.0% 60% TCL Communication 6.0% 6.6% 0.6% 50% Apple 6.3% 3.8% -2.5% 40% Top 4 Latam 65.3% 66.6% 1.3% 30% Top 6 Latam 77.5% 77.0% -0.5% 20% 10% Volumes (m units) 0% Samsung 17.6 17.8 1.2% Lenovo (Motorola) 11.1 12.1 9.4% Huawei 5.8 10.3 78.1% Samsung Lenovo Huawei LG Electronics 5.4 4.6 -14.6% LG Electronics TCL Communication Apple TCL Communication 3.6 4.4 22.1% BLU Products ZTE Asus Sony Others Apple 3.8 2.6 -32.7% Latam 60.9 67.2 10.4%

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019 5 November 2019 35 Macquarie Research Global smartphones

Middle East and Africa Smartphone penetration in Middle East and Africa is below the global average at 73% in 1H19. Smartphone shipment growth has slowed from the peak of 76% in 2014 to 4% in 2018. Total volume reached 79.5m units in 1H19, declining by 2.8% YoY, as the pace of smartphone adoption decelerated. We forecast smartphone growth in the region to reach 2%/3%/3% over 2020/21/22E, with 5G volume penetration to reach 6%/12%/17% over the same period.

Fig 99 Smartphone penetration in MEA Fig 100 MEA Smartphone shipment and growth

(m units) 100% 200 45% 87% 90% 83% 86% 180 40% 79% 39% 80% 74% 72% 73% 160 35% 71% 69% 70% 61% 140 30% 56% 58% 60% 55% 120 25% 50% 43% 100 20% 40% 33% 80 15% 29% 14% 30% 11% 20% 60 10% 20% 15% 40 5% 4% 3% 3% 3% 3% 10% 2% 20 0% 0% 0% 0 -5% 2011 2012 2013 2014 2015 2016 2017 2018 1H19 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

MEA Global average smartphone penetration MEA YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Top four brands are consolidating the market Samsung, Tecno, Huawei and Mi-Fone are the top four brands in the MEA region, accounting for 65.2% share in 1H19. White box is still a sizeable part of the market with a 25-26% share. Samsung is still the dominant brand, with a 37.8% share in 1H19. Huawei is steadily gaining share with a 21.6% volume increase in 1H19 at the expense of other smaller brands and Apple. Apple’s market share dropped from 6.4% in 1H18 to 3.4% in 1H19.

Fig 101 MEA smartphone market share Fig 102 Top 6 smartphone vendors in MEA

Market share 1H18 1H19 +/- Samsung 37.0% 37.8% 0.8% 100% 90% Tecno Telecom 10.8% 11.0% 0.2% 80% Huawei 9.4% 11.8% 2.4% 70% Mi-Fone 4.1% 4.6% 0.5% 60% Apple 6.4% 3.4% -3.0% 50% TCL Communication 1.3% 0.9% -0.4% 40% Top 4 in MEA 61.4% 65.2% 3.9% 30% Top 6 in MEA 69.1% 69.6% 0.5% 20% 10% Volumes (m units) 0% Samsung 30.3 30.1 -0.8% Tecno Telecom 8.8 8.8 -0.7% Huawei 7.7 9.4 21.6% Samsung Tecno Telecom Huawei Mi-Fone 3.3 3.6 9.2% Mi-Fone Apple TCL Communication Apple 5.2 2.7 -47.7% LG Electronics Orange Xiaomi TCL Communication 1.1 0.7 -34.0% ZTE Other brands white-box MEA 81.8 79.5 -2.8%

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 36 Macquarie Research Global smartphones

North America Smartphone volume in North America has been declining YoY for the past five quarters, due to the saturation of demand on penetration reaching 97%. In 1H19, smartphone volumes declined by 13.7% to 72.1m units. We expect volume decline to soften to 3% in 1H20E, recover by +2% YoY in 2H20E, followed by 2% and 3% growth in 2021-22E, driven by 5G replacement demand.

Fig 103 Smartphone penetration in North America Fig 104 North America smartphone shipment and growth

(m units) 97% 97% 200 20% 100% 91% 94% 88% 89% 87% 90% 83% 86% 180 81% 79% 15% 80% 74% 160 71% 71% 70% 140 10% 7% 60% 56% 56% 120 5% 50% 100 4% 3% 43% 2% 2% 1% 0% 40% 80 0% 29% -2% 30% 60 -5% -7% 20% 40 -10% 10% 20 -12% 0% 0 -15% 2011 2012 2013 2014 2015 2016 2017 2018 1H19 2015 2016 2017 2018 2019E2020E 2021E2022E 2023E2024E

North America Global average smartphone penetration North America YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

The top four brands – Apple, Samsung, LG and Lenovo (Motorola) – have been consolidating the market in the past four years, gaining 3.1% share in 1H19 to 88.7%. Presence of the open-channel Chinese brands, including Huawei, is very limited, as the market is telco-channel focused.

Fig 105 North America smartphone market share Fig 106 Top 6 smartphone vendors in North America

Market share 1H18 1H19 +/-

100% Apple 41.4% 42.5% 1.1% 90% Samsung 25.5% 27.6% 2.2% 80% LG Electronics 15.1% 12.3% -2.7% 70% Lenovo (Motorola) 3.7% 6.2% 2.6% 60% TCL Communication 3.9% 3.6% -0.3% 50% ZTE 5.1% 2.1% -2.9% 40% Top 4 in North America 85.6% 88.7% 3.1% 30% Top 6 in North America 94.6% 94.4% -0.2% 20% 10% Volumes (m units) 0% Apple 34.6 30.6 -11.4% Samsung 21.3 19.9 -6.4% LG Electronics 12.6 8.9 -29.4% Apple Samsung LG Electronics Lenovo (Motorola) 3.1 4.5 46.6% Lenovo TCL Communication ZTE BLU Products Kyocera HTC TCL Communication 3.3 2.6 -20.5% Huawei Others ZTE 4.2 1.5 -63.6% North America 83.5 72.1 -13.7%

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 37 Macquarie Research Global smartphones

Europe (EU) Smartphone volumes in Europe have been declining for the past seven quarters, as smartphone penetration has been saturating at 91-92% since 2017. Total market volumes declined by 3% in 1H19 to 90.1m units. We expect volume weakness in EU to continue at -2% between 2H19 and 1H20, followed by a 5G-driven recovery of 1-2% in 2021-22E.

Fig 107 Smartphone penetration in Europe Fig 108 Europe Smartphone shipment and growth

(m units) 100% 92% 200 20% 89% 91% 91% 86% 87% 19% 90% 84% 85% 83% 198 79% 80% 74% 74% 15% 71% 196 70% 66% 194 60% 54% 56% 10% 192 50% 43% 190 40% 5% 29% 188 3% 30% 2% 2% 186 1% 1% 20% 0% 0% -2% 10% 184 -3% -2% 0% 182 -5% 2011 2012 2013 2014 2015 2016 2017 2018 1H19 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

Europe Global average smartphone penetration Europe YoY

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

Market share to reshuffle in 2H19 Europe has been the key battle ground for the Chinese brands to gain market share. Huawei’s market share in Europe has increased from 6% in 2015 to 23% in 1H19 at the expense of Samsung, Apple and other brands. However, Huawei’s success story is coming to a halt, as the US trade ban forbids the company’s access to Google apps and services in new devices. We expect market share in Europe to reshuffle in favour of other top Android brands. Xiaomi is aggressively building out channels in Europe and has gained 3.8ppts of market share, reaching 4.5% in 1H19, per Gartner. Per Canalys, Xiaomi had a 9.6% market share in Europe in 2Q19. Apple had a steady market share of about 20% between 2016 and 2018 but saw 2.2ppt of YoY share loss to 16.4% in 1H19.

Fig 109 Europe smartphone market share Fig 110 Top 6 smartphone vendors in Europe (EU)

Market share 1H18 1H19 +/-

100% Samsung 36.3% 33.9% -2.3% 90% Huawei 16.6% 22.8% 6.2% 80% Apple 18.6% 16.4% -2.2% 70% Xiaomi 0.7% 4.5% 3.8% 60% Wiko 4.9% 3.4% -1.5% 50% ZTE 3.6% 2.3% -1.2% 40% 30% Top 4 in Europe 72.2% 77.7% 5.5% 20% Top 6 in Europe 80.7% 83.5% 2.8% 10% Volumes (m units) 0% Samsung 33.7 30.6 -9.3% Huawei 15.4 20.5 33.2% Apple 17.3 14.8 -14.5% Samsung Huawei Apple Xiaomi 0.7 4.1 500.0% Xiaomi Wiko ZTE LG Electronics Lenovo OPPO Wiko 4.5 3.1 -32.0% TCL Communication Others ZTE 3.3 2.1 -36.8% Europe 93.0 90.1 -3.1%

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 38 Macquarie Research Global smartphones

Appendix 2: Fingerprint sensor Fingerprint sensor penetration reached 87% in our sample of 132 new smartphones.

• Under-display sensor: Major brands started adopting under-display fingerprint solutions in 2H18, and penetration of our 2019 new phones sample has reached 43%. Optical solutions represent 40% of the overall mix, while ultrasonic solutions, which used in Samsung’s S and Note series, only account for 3%. Xiaomi, Oppo and Vivo’s adoption of under-display sensor has reached over 50%.

• Capacitive fingerprint sensing has been around for several years and has become a very affordable authentication option; adoption for rear-mounted and side mounted capacitive sensor reached 38% and 6% of the sample mix.

• About 13% of the mix has no fingerprint sensors, due to adoption of 3D face recognition front camera or adoption of AI face unlock software feature in low-end devices.

Technology upgrade While rear-mounted and side-mounted capacitive fingerprint solutions serve as a low-cost solution for mid-to-low end smartphones, the technology adopted in flagship models continues to improve. As 5G smartphones require about 20% increase in battery capacity, brands are requiring thinner fingerprint module form factors to reduce height by more than two-thirds of existing optical solutions. These new thin-type fingerprint sensors are expected to start mass production in 4Q19, which should benefit fingerprint module makers like Q Tech to improve product mix.

Fig 111 Fingerprint sensor penetration by technology Fig 112 Fingerprint penetration by brand

100% 10% 5% 4% 8% 90% 17% 18% 5% 27% 25% 80% n/a 11% 36% 70% 42% side-mounted 13% 43% 6% 60% 55% 50% 39% 45% 100% 92% 58% 40% 30% 19% 60% Under-display 53% 20% (optical) 33% 27% 27% 40% 10% 24% 17% 0% Rear-mounted 38%

Under-display (optical) Under-display (ultrasonic)

Under-display Rear-mounted side-mounted (ultrasonic) 3% n/a

Source: Macquarie Research, GSMArena, November 2019 Source: Macquarie Research, GSMArena, November 2019

5 November 2019 39 Macquarie Research Global smartphones

Appendix 3: supply chain

Fig 113 Camera module supply chain Voice coil motor/ Optical Camera module Plastic lens image stabilisation Sensor packaging Largan Alps Sony LG Innotek Apple Genius Sharp Kantatsu O-Film

Largan TDK Sony Sunny Optical Sunny Optical Alps Samsung LuxVisions Kantatsu Semco Omnivision O-Film Sekonix Jahwa Q Tech AAC Tech ZET (Chinese domestic) Semco Android Genius JSS Optical (Chinese LG Innotek domestic) Newmax Shanghai Billu (Chinese Truly domestic) Holitech Primax Source: Macquarie Research, November 2019

Fig 114 Android fingerprint module supply chain Sensor Fingerprint module packaging

Optical solution Potential new players for optical solution O-Film Goodix Silead Q Tech Egis OXI Truly Vkansee Holitech Ultrasonic GalaxyCore Lens Tech Qualcomm

Capacitive (low-cost) Goodix Fingerprint Cards Egis Synaptics Source: Macquarie Research, November 2019

Fig 115 Stocks with high 5G exposure Smartphone + base station Company Ticker Analyst comments exposure Analyst Antenna Luxshare 002475 CH - NR Base station antenna, filters, 5G CPE RRU/AAU, LCP antenna 80-90% Non-rated SEMCO 009150 KS - OP 75% Daniel Kim Sunway 300136 CH - NR LDS and LCP antenna for Android smartphones 80-85% Non-rated Baseband, AP TSMC 2330 TT - OP Increasing silicon content 50% Patrick Liao Samsung 005930 KS - OP 5G SoC, smartphones 65% Daniel Kim MediaTek 2454 TT - UPF 5G SoC Patrick Liao Qualcomm QCOM US - NR 5G SoC Non-rated Back-end ASE 3711 TT - OP 20% Patrick Liao Inari INRI MK - UPF The single-source OSAT for Broadcom’s FBAR RF filters, supplying high-mid Ben Shane Lim band filters for Apple and Samsung. Additional content growth. JCET 600584 CH - OP 15% Patrick Liao KYEC 2449 TT - OP Longer testing time for 5G chips, HiSilicon for base station. 35% Patrick Liao Battery Desay 002920 CH - NR 5G smartphone requires high power battery. Non-rated TDK 6762 JP - OP 5G smartphone requires high power battery. TDK dominates smartphone Hiroshi Taguchi battery business (35% global market share in 2018) and to benefit from the increasing Li-ion battery sales for 5G smartphone. 5 November 2019 40 Macquarie Research Global smartphones

Fig 115 Stocks with high 5G exposure Smartphone + base station Company Ticker Analyst comments exposure Analyst Samsung SDI 006400 KS - OP Increasing battery density on higher power consumption 10% Daniel Kim LG Chem 051910 KS - OP 5G smartphone requires high power battery. 1% Anna Park Sunwoda 300207 CH - NR 5G smartphone requires high power battery. Non-rated PCB/substrates Kinsus 3189 TT - N An IC substrate maker and benefits from 5G in (1) increasing ABF substrate 50%-60% Kaylin Tsai demand from FPGA in base stations and (2) increasing BT substrate demand from 5G components (RF IC, antenna) in smartphones. SEMCO 009150 KS - OP 75% Daniel Kim Shengyi Tech 600183 CH - OP Huawei’s 3rd largest PCB supplier for telecom equipment. World’s 2nd 30-40% Erica Chen largest laminate company in capacity, and it's closing the tech gap with Rogers and Panasonic. Shennan Circuits 002916 CH - N China's second largest PBC maker with 60% of sales contribution from 60-70% Erica Chen telecom clients. 5G migration to lift telecom PCB demand. TTM Technologies TTMI US - NR A supplier of printed circuit boards, backplane, and transceivers into Non-rated smartphones, base stations, and antenna. Unimicron 3037 TT - NR 4th largest PCB supplier in the world with clients including Apple, Huawei 33% Non-rated (smartphone and base station), Intel, AMD, Nvidia, Xilinx, etc. WUS 002463 CH - N Huawei's 2nd largest PCB supplier for telecom equipment. 5G migration to 65% Erica Chen lift telecom PCB demand. Zhen Ding 4958 TT - N Benefit from iPhone antenna FPCB design upgrade from modified PI to LCP Kaylin Tsai and increase in overall antenna FPCB content per box. In 2020 both firms Flexium 6269 TT- N are targeting to penetrate into LCP. From execution track record ZDT may have better chances to get higher allocation. Passives Fenghua Advanced 000636 CH - NR Non-rated KEMET KEM US - NR KEM supplies tantalum polymer into base stations with strong design wins Non-rated and has flex suppression sheets for 5G smartphones (historically Apple). Murata 6981 JP - OP Increase MLCC sales per smartphone. 5G smartphone will require small size Hiroshi Taguchi and higher capacitance MLCC, and the top MLCC makers have SEMCO 009150 KS - OP 75% Daniel Kim technological advantage in that area. Taiyo Yuden 6976 JP - OP Hiroshi Taguchi Sunlord 002138 CH - NR Increasing need of passive component miniaturization (from 0201 to 01005) Non-rated due to limited PCB area size of 5G phone and rising number of usage due to more supported bands (from 40+ bands in 4G to 90+ bands in 5G) RF component Broadcom AVGO US - NR For both Sub-6GHz and mmWave 5G, new RF technology will be required to Non-rated manage higher frequency. Contents per smartphone will increase. Qorvo QRVO - NR Skyworks SWKS - NR Murata 6981 JP - OP Potential to expand the business in RF especially for the business with Hiroshi Taguchi Chinese smartphone makers Taiyo Yuden 6976 JP - OP Hiroshi Taguchi Maxscend 300782 CH - NR Non-rated GaAs foundry SanAn 600703 - NR Non-rated WinSemi 3105 TT - OP 5G base station PA, beneficiary of the US-China trade ban Patrick Liao PMIC SG Micro 300661 CH - NR Non-rated SPE Chroma 2360 TT - N System level testers (semiconductor testers) for 5G RF/ PAs that do Jeff Ohlweiler compatibility testing, temperature (high/low extremes) and burn-in. Photonics tester for both VCSEL and EEL Advantest 6857 JP - OP Increasing demand for chip testers. The higher complexity of 5G SoCs will Damian Thong increase test times and drive need for chip tester upgrades in areas such as RF testing. Tokyo Electron 8035 JP - OP Benefits from investment in logic/foundry capacity for 5G devices and will Damian Thong see market share gains with the recovery of DRAM sector capex in support of the migration to LPDDR5 and DDR5 DRAM for 5G smartphones and datacentre infrastructure. Anritsu 6754 JP - NR Increasing demand for 5G chip testers. Non-rated Source: Company data, Macquarie Research, November 2019

5 November 2019 41 Macquarie Research Global smartphones

Fig 116 Huawei supply chain and revenue exposure Company Ticker Component Revenue exposure (%)

China Accelink 002281 CH Optical component Biel Crystal private Smartphone cover glass BOE 000725 ch Panel 15 Broadex 300548 CH plitters, waveguide, optical attenuators, fibers, PLC 30 CATL 300750 CH Battery Connaught private smartphone ODM Crystal-Optech 002273 CH optical components 16 Desay 000049 CH Battery 15 ESUN 002751 CH display 16 Everwin 300115 CH Casing 9 FII 601138 CH Foxconn Industrial, server, base stations, switch 15 Getto Acoustic 20 Goertek 002241 CH Acoustics 15 Goodix 603160 CH Fingerprint IC and touch IC 15 Guangdong Janus 300083 CH molds 25 Hgtech 000988 CH Optical component Huaqin private Smartphone ODM Huizhou Speed Wireless 300322 CH mobile phone antennas 14 JCET 600584 CH IC Packaging and Testing 7 Jonhon 002179 CH Connector Kingsignal Tech 300252 CH cables 17 Konwn private Smartphone ODM Lens Tech 300433 CH Smartphone cover glass 15 Luxshare 002475 CH Connector, wireless charging transmitter 10 O-film 002456 CH Camera module, fingerprint module, touch 25 SCC 002916 CH Telecom PCB 25 Shenzhen Ellington 10 Shenzhen SGD Info 13 Shenzhen Sunshine Laser 300227 CH production laser 10 Shenzhen Sunyes 002388 CH assembly 45 Shenzhen Tat Fook 300134 CH frequency filter, combiners and microwave components 13 Sunlord 002138 CH Inductor 13 Sunway Comm 603333 CH Antenna, wireless charger, precision component 10 Sunwoda 300207 CH Battery 30 Suzhou Chunxing 002547 CH casing 20 SYE PCB SYTECH 600183 CH Telecom PCB 10 Tianma 000050 CH Panel 18 Wingtech 600745 CH smartphone ODM 20 Wuhan Fingu 002194 CH RF subsystems and antenna feeding systems 60 WUS 002463 CH Telecom PCB 25 WUS Printed Circuit 002463 CH PCB Zhongguang Lightning 300414 CH electromagnetic protection 15 Zhongli Group 002309 CH Optical cables Zowee 002369 CH smartphone ODM 30 HK AAC 2018 HK Acoustics, haptic 10 BYD Electronics 1211 HK Casing, smartphone cover glass 25 Q Tech 1478 HK Camera module, fingerprint module 20 SMIC 981 HK Power management IC for HiSilicon 20 Sunny Optical 2382 HK Camera module, lenses 22 Tongda 698 HK Casing 10 ChinaSoft 354 HK software 55 O Net 877 HK optical components 20

Japan Furukawa 5801 JP Optical fibre and cable HRS Connector NTT Electronics Optical component Sony 6758 JP Lenses Sumitomo 8053 JP Optical fibre and cable Toshiba 6502 JP Memory Murata 6981 JP MLCC Morpho 3653 JP image software 25

Korea SK Hynix 000660 KR Memory 15 Samsung 005930 KR Panel, Memory Wisol 122990 KR SAW filters and Duplexers 15

5 November 2019 42 Macquarie Research Global smartphones

Fig 116 Huawei supply chain and revenue exposure Company Ticker Component Revenue exposure (%) Taiwan Accton 2345 TT Switch 10 ASE 3711 TW Backend testing 5 Career 6153 TT FPCB 5 CHPT 6510 TT Wafer/ IC testing board 5 Compeq 2313 TW PCB Elite Materials 2383 TT CCL 7 Hon Hai 2317 TW Smartphone, PC ODM Kinsus 3189 TT IC Substrate 5 KYEC 2449 TT IC testing 15 Largan 3008 TW Lenses 20 Macronix 2337 TW NOR Flash MediaTek 2454 TT Smartphone , consumer IC 5 Nanya Tech 2408 TW Memory Novatek 3034 TT Smartphone driver IC 7 Realtek 2379 TT Networking IC 5 TSMC 2330 TT Foundry for smartphone, consumer, telecom equipment IC 10 TXC 3042 TW Crystal oscillator UMC 2303 TT Foundry for smartphone driver IC 5 Unimicron 3037 TW PCB Vanguard 5347 TT Foundry for smartphone driver IC 5 Win Semi 3105 TT Foundry for smartphone PA 15 ZDT 4958 TT FPCB/HDI 5 USA Amphenol APH US Connectors and cables Analog Devices ADI US Analog chip 5 Broadcom AVGO US Wifi BT module 5 Cypress CY US NOR Finisar FNSR US VCSEL 10 II-VI IIVI US Optical component, IR component 10 InPhi IPHI US analog semiconductor, speed interface 15 Intel INTC US Server, storage CPU Keysight KEYS US Testing equipment Lattice LTTC US FPGA, CPLD 5 Littelfuse LFUS US Fuse Lumentum LITE US Optical component 15 Marvell MRVL US Switch, Ethernet transceiver 5 Micron MU US Memory 15 Molex Private Connectors and cables Neo-Photonic NPTN US Optical component 35 On Semi ON US OIS and auto focus, tunable RF components, PIMIC Qorvo QRVO US Power amplifiers, antenna tuners, filters, Wi-Fi 23 Qualcomm QCOM US Smartphone AP Seagate STX US SSD, flash memory Skyworks SWKS US Analog control Ics 10 Synopsys SNPS US Silicon iP, design & verification Texas Instrument TI US DSP, analog chips TTM Technologies TTMI US PCB Xilinx XLNX US FPGA chip 8 Semtech SMTC US analog and mixed-signal semiconductors 5 Source: Bloomberg, Macquarie Research, November 2019

5 November 2019 43 Macquarie Research Global smartphones

Fig 117 Apple exposure supply chain Name Ticker Product iPhone iPad Watch Mac-book iMac /iPod Total

Semi TSMC 2330 TT Foundry 11-15 0-5 <3 <1 20-25 ASE 3711 TT Assembly, Wi-Fi module, Fingerprint 10-15 0-5 5-10 <1 <1 20-25 module and SiP Chipbond 6147 TT Assembly/test for DDIC 10 <5 10-15 JCET 600584 CH Assembly <5 <5 WinSemi 3105 TT 3D sensing and PA ~15 ~15 Parade 4966 TT Transmission IC ~25 ~15 ~40 Powertech 6239 TT Memory 5~10 Casings Lens Tech 300433 CH Glass casing 25-35 10-15 5-10 40-50 Biel Crystal Private Glass casing 25-35 10-15 5-10 40-50 Catcher 2474 TT Metal casing 40-45 5-10 ~15 ~2 65-70 Casetek 5264 TT Casing 50-55 30 80-85 FTC 2354 TT Metal casing 50 10 7 65-70 Camera/ Imaging Largan 3008 TT Camera lens 20-30 ~5 30 Genius 3406 TT Lens 50-60 10-20 70 ASM Pacific 522 HK AA equipment <1 <1 <1 Himax HIMX US 3D sensing ~5 ~5 O-film 002456 CH Camera modules <5 <5 Cowell 1415 HK Camera modules 80-85 80-85 Acoustics/haptics AAC 2018 HK Acoustics, Haptics, RF 30-40 <5 15-20 55-60 Goertek 002241 CH Acoustic 25-30 10-15 40 Merry 2439 TT Acoustic 15-20 15-20 Jinlong 300032 CH Haptics <5 10-15 ~15 Primax 4915 TT Acoustic 15~20 ODM Hon Hai 2317 TT ODM 25-30 10 5 2 45-50 Pegatron 4938 TT ODM 50-55 ~5 55-60 Quanta 2382 TT ODM 5-10 25-30 5-10 40-50 Wistron 3231 TT ODM 15-20 15-20 Compal 2324 TT ODM 5-10 5 10-15 Inventec 2356 TT ODM 5-10 5-10 Display GIS 6456 TT Touch Panel, pressure sensor 35-40 40-45 75-85 Radiant 6176 TT BLU <5 30-40 <5 <5 40-45 TPK 3673 TT Touch Panel, pressure sensor 20-25 20-25 10-15 50-55 PCB Career 6153 TT FPCB 35-40 10-15 5-10 5-10 60-70 Compeq 2313 TT PCB 15-20 15-20 30-40 Flexium 6269 TT FPCB 70-75 5-10 5-10 80-90 Kinsus 3189 TT IC substrate 25-30 25-30 Unimicron 3037 TT PCB 10-15 5-10 5-10 5-10 30-40 ZDT 4958 TT FPCB 65-75 5-10 5-10 75-85 Taiflex 8039 TT FCCL 15-20 0-5 0-5 20-25 Nanya PCB 8046 TT IC substrate 0-5 5-10 0-5 10-15 Elite Material 2383 TT CCL 5-10 0-5 0-5 5-15 Misc. components Luxshare 002475 CH Connectors, speaker boxes, haptics 20-25 5-10 5-10 40 Sunway 300136 CH Antenna, RF shields, Lightening 25-30 10 <5 <5 40 connectors Tongda 698 HK Waterproof components 5-10 5-10 Everwin 300115 CH Connectors <5 <5 Cheng Uei 2392 TT Cable and connector 35 10 5 5 5 60 Delta (Cyntec) 2308 TT Passive component ~5 <3 <3 7-10 Dynapack 3211 TT Battery module 5 40-45 15-20 60-70 SZS 3376 TT Hinge 2 2 13-15 3-4 20-25 Han’s Laser 002008 CH Laser cutting/welding/marking 35-40 <5 <5 40-45 Jarllytec 3548 TT Hinge 20-25 5-10 25-30 USISH 601231 CH SiP 5-10 0-5 15 Darfon 8163 TT LCD inverter board 15-20 15-20 TXC 3042 TT Tuning fork 20-25 5-10 5-10 5 40-45 Auras 3324 TT Thermal dissipation module 15-20 15-20 Simplo 6121 TT Battery module 20-25 15-20 15-20 60-65 Asia Vital 3017 TT Thermal dissipation module 10-15 10-15 Lite-on 2301 TT Charging components 5-10 5-10 15 25-30 GLT 4935 TT Lcd inverter board 20-25 5-10 5-10 40 Sunrex 2387 TT Keyboard 25-30 25-30 Source: Company data, Macquarie Research, November 2019

5 November 2019 44

5 November 2019 Hong Kong

EQUITIES Sunny Optical (2382 HK) Sunny’s profit growth by segment Multi-camera upgrades to propel growth (Rmbm) 10,000 26% 24% 8,000 Key points 22% 6,000 20%  We initiate coverage with Outperform and a target price of HK$163.56, 18% based on 30x 2020E EPS, implying potential upside of 29%. 4,000 16% 14%  Increasing adoption of multi-camera modules should drive volume growth 2,000 12% and margin expansion in camera modules and lens sets in coming years. - 10%  We forecast Sunny’s net income will show a CAGR of 43% over 2019-20-21 on increasing profit contribution from the lens business.

Optical components Optoelectronic products

Optical Instruments Gross margin (RHS) Source: Company data, Macquarie Research, November 2019 Multi-camera upgrade 2382 HK Outperform Major smartphone camera upgrades occur every three years and we are Price (at 08:50, 01 Nov 2019 GMT) HK$126.80 observing dual to triple and quad camera upgrades starting in 2019. We see that specs upgrades have accelerated in 2H19 for the 132 smartphones we surveyed. Valuation HK$ 163.56 About 80% of the new smartphones launched in 2H19 have triple or quad camera - PER 12-month target HK$ 163.56 systems, and 60% of the main cameras have resolution of 40MP or above. We Upside/Downside % +29.0 forecast the lens market size will increase from our estimate of 3.6bn sets in 2018 12-month TSR % +30.0 to 4.1bn in 2019, 4.8bn in 2020, and 5.6bn sets in 2021, with the average number Volatility Index High of cameras per smartphone increasing from 2.4 in 2018 to 2.9, 3.3 and 3.8 units, GICS sector respectively, in 2019, 2020 and 2021. Technology Hardware & Equipment Gross margin recovery Market cap HK$m 139,081 Market cap US$m 17,745 Gross margin took a hit in 1H19 due to production challenges of various new Free float % 61 projects, including the periscope camera for Huawei. However, with the ongoing 30-day avg turnover US$m 70.7 production line optimisation and yield improvements, we believe the company’s Number shares on issue m 1,097 camera module gross margin will improve meaningfully in 2H19. Product mix improvement in the handset lens set business should also drive overall Investment fundamentals improvement in profitability. We expect operating leverage to come into play in Year end 31 Dec 2018A 2019E 2020E 2021E 2020-21, with operating margin expanding from 11% in 2019E to 14% in 2020 Revenue m 25,932 36,572 43,833 50,431 and 16% in 2021 on better yield and mix. EBIT m 2,907 4,074 6,166 8,248 EBIT growth % -4.4 40.1 51.4 33.8 Reported profit m 2,491 3,403 5,252 7,241 Competition turning profit-focused Adjusted profit m 2,491 3,403 5,252 7,241 We believe the fierce competition in camera modules has gradually eased in EPS rep Rmb 2.27 3.10 4.79 6.60 2019 as competitors are focusing on improving cashflow and profitability rather EPS rep growth % -14.7 36.7 54.2 37.9 EPS adj Rmb 2.27 3.10 4.79 6.60 than aggressively expanding capacity to gain volume share. The handset lens set EPS adj growth % -14.7 36.7 54.2 37.9 market remains a healthy duopoly between Largan and Sunny, where both PER rep x 50.1 36.7 23.8 17.2 suppliers are focused on maximising profits through technology upgrades for PER adj x 50.1 36.7 23.8 17.2 customers. Sunny remains a leader in the Samsung supply chain, while Total DPS Rmb 0.57 0.78 1.20 1.65 Total div yield % 0.5 0.7 1.1 1.5 progressively gaining share in the high-end Chinese Android phone market. ROA % 15.1 15.6 18.8 20.7 ROE % 29.8 32.1 37.1 37.5 Initiate with Outperform rating EV/EBITDA x 34.6 24.1 15.7 12.0 We forecast the camera upgrade cycle and the increasing adoption of cameras in Net debt/equity % 35.6 35.0 16.6 -2.1 P/BV x 13.5 10.4 7.6 5.6 cars to drive net income growth of 37%, 54% and 38% over 2019-20-21E. We

Source: FactSet, Macquarie Research, November 2019 initiate with Outperform and a 12-month target price of HK$163.56, based on 30x (all figures in Rmb unless noted, TP in HKD) 2020E EPS, implying 29% potential upside. Short-term catalysts: New phones

launched with triple/ quad cameras in 4Q19; gross margin improvement in 2H19. Analysts

Macquarie Capital Limited Fundamental catalysts: Number of cameras in smartphones increasing from 2.4

Cherry Ma +852 3922 5800 in 2018 to 3.8 in 2021E with visible content growth for camera modules and [email protected] lenses. Camera module competition becoming more rational focusing on profits.

Nicolas Baratte +852 39225801 Overall smartphone growth in the medium term driven by 4G to 5G replacement. [email protected] Downside risks to our forecasts include potential slowdown in specs upgrades

and increasing competition, which could hurt pricing and margins. 5 November 2019 45 Macquarie Research Global smartphones

Inside Sunny Optical

Company profile Multi-camera to propel growth 47 Founded in 1984 and headquartered in Yuyao, China, Sunny Optical is one of the Triple and quad camera upgrades in 2H19 48 world’s leading companies in optoelectronic design and manufacturing, with four Three growth engines 49 production bases in China. The company is China’s leading manufacturer of Competition 59 smartphone camera modules and the world’s second-largest smartphone lens maker, providing mid-range to premium products to top Android smartphone Initiate coverage with Outperform 64 vendors. The company is also the world’s leading supplier of automotive camera

lenses to global Tier-1 suppliers including Autoliv, Bosch and Continental. Customer revenue mix (2018) Sunny’s key strategy is to become the leading supplier to its customers through R&D and technology advancement. Sunny has R&D centres in China, Singapore, Korea and the US. Huawei The company’s revenue registered a five-year CAGR of 35% between 2013 and Others 22% 32% 2018, driven by smartphone camera upgrades and market share gains in various product lines. However, gross margin took a hit in 2018 and 1H19 due to shrinking margin premium on dual cameras and increasing competition. We expect Sunny’s gross margin to recover, driven by the increasing revenue Top 2-5 46% contribution from handset lenses and efficiency and yield improvement in the camera module business.

Source: Company, Macquarie Research, November 2019 Fig 1 2382 HK rel HSI performance, & rec history

Return on Equity

50% 45% 47% 40% 37% 37% 35% 34% 30% 29% 30% 25% 21% 20%18% 19% 15% 10% 5% 0%

Return on equity

Source: Company, Macquarie Research, November 2019 Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period.

Source: FactSet, Macquarie Research, November 2019 PE bands (all figures in Rmb unless noted, TP in HKD)

Rmb 180 160 140 120 100 80 60 40 20

Feb-16 Feb-17 Feb-18 Feb-19

Nov-15 Aug-16 Aug-17 Nov-17 Nov-18 Aug-19 Aug-15 Nov-16 Aug-18

May-15 May-16 May-17 May-18 May-19

Price 12x 18x 24x 30x 36x Source: Bloomberg, Macquarie Research, November 2019

5 November 2019 46

Macquarie Research Global smartphones

Multi-camera upgrades to propel growth

Investment summary

Increasing cameras per smartphone • We’ve surveyed 132 new smartphones launched by the top six smartphone; camera specs Multi-cam penetration forecast upgrades in 2H19 are accelerating. About 80% of the new smartphones launched in 2H19 have 100% 90% triple or quad cameras, to 46% in 1H19. Resolution migration has also increased in 2H with 80% 70% almost 60% 40MP and above main cameras, compared to 38% in 1H19. 60% 50% 45% 40% • We estimate the number of cameras per smartphone reached 2.4 units in 2018, and we 30% 31% forecast the number of lens sets per smartphone will reach 2.9 units, 3.3 units and 3.8 units in 20% 16% 10% 0% 2019-20-21E, with total lens set volumes reaching 5,627m sets by 2021E.

Camera module segment to benefit from design complexity Single Dual Triple Quad Other • Sunny has been a leading player in multi-camera module assembly technology in China, and is

gaining share in the Samsung supply chain. We expect production line optimisation in the past Source: Macquarie Research, Gartner, November 2019 18 months to show efficiency and yield improvement in 2H19.

• Domestic competition is less severe, with O-Film focusing on cashflow and profits after incurring asset write-off in 2018.

Limited high-end lens players in the market

Lens shipment and ASP • Sunny has been delivering strong handset lens volume growth, at 56% and 38% in 2018 and 9M19, driven by market growth and share gain. ASP has also increased steadily on an (m sets) (Rmb) 1000 4.4 improving product mix. 900 4.2 800 700 4.0 • There are relatively few competitors in the high-end handset lens segment. Sunny’s high-end 600 3.8 500 design and production technology has been improving and the company has become a stable 400 3.6 300 3.4 second source after Largan in the Chinese market. Largan’s potential capacity constraints in the 200 3.2 100 coming two years will benefit Sunny, in our view. 0 3.0 2012 2013 2014 2015 2016 2017 2018 Sunny Optical's handset lens shipment Increasing optical components per car Handset lens ASP • Sunny is the world’s largest vehicle lens provider, specialising in ADAS lenses with an estimate Source: Macquarie Research, Company data, November 2019 of 27-28% market share in 2018. ADAS lens sets account for over 50% of the segment’s shipment mix. • Sunny’s vehicle lens set shipments have been growing at a CAGR of 35% over 2013 to 2018, and we expect them to grow at 20% over 2019-20-21E on the increasing penetration of cameras per vehicle.

• Besides lens sets for front view, surround view, back view, in-cabin view and sensing, the company also offers various head-up display (HUD) solutions, various Lidar solution; and vehicle camera modules. Sunny is a key beneficiary of the autonomous driving theme. Optical component drives profit growth Growth (Rmbm) 10,000 26% • In 2019, we expect triple and quad cameras with specs upgrades in high-end and flagship 24% 8,000 smartphones to drive volume demand. We forecast gross margin will recover HoH in 2H19 after 22%

6,000 20% the company went through a production learning curve and challenges of various new products, 18% including periscope-style cameras. We forecast revenue CAGR of 25% over 2019-20-21E. 4,000 16% 14% 2,000 12% Valuation - 10% • We forecast the camera upgrade cycle and the increasing adoption of cameras in cars to drive

Optical components net income growth of 37%, 54% and 38% over 2019-20-21E. We initiate with Outperform and a Optoelectronic products Optical Instruments 12-month target price of HK$163.56, based on 30x 2020E EPS, implying 26% potential upside. Gross margin (RHS) Source: Macquarie Research, Company Data, November 2019

5 November 2019 47 Macquarie Research Global smartphones

Triple and quad camera upgrades in 2H19 Major smartphone camera upgrades occur every three years and we are observing dual to triple and quad camera upgrade starting 2019. We’ve surveyed 132 new smartphones launched by top six smartphone brands including Samsung, Apple, Huawei, Oppo/Realme, Vivo and Xiaomi, to identify the latest camera trends. Specs upgrades in 2H19 have accelerated. There are 489 cameras in total, or an average of 3.7 cameras per device, with 1.0 front camera and 2.7 back cameras. About 80% of the new smartphones launched in 2H19 have triple or quad camera systems, compared to 46% in 1H19. Resolution migration has also accelerated in 2H, with almost 60% of the main cameras with 40MP or above, compared to 38% in 1H19.

Fig 2 Back-camera form factor in new smartphones Fig 3 Back main camera resolution upgrades in 2H19

60% 60%

49% 51% 50% 50% 42% 39% 40% 40% 38% 38% 32% 30% 30% 20% 20% 20% 14% 13% 9% 10% 6% 10% 7% 7% 7% 4% 4% 4% 3% 1% 1% 0% 0% Single Dual Triple Quad 8MP 10-13MP 16MP 20-25MP 32MP 40-48MP 64MP 108MP

1H19 2H19 1H19 2H19

Source: Macquarie Research, GSMArema, November 2019 Source: Macquarie Research, GSMArema, November 2019

Increasing number of cameras per smartphone We estimate the number of cameras per smartphone reached 2.4 units in 2018, driven by Huawei’s lead in triple-camera upgrades and the overall increase in dual-camera adoption in major brands. We forecast the number of lens sets per smartphone will reach 2.9 units, 3.3 units and 3.8 units in 2019-20-21E, with total lens set volumes reaching 5,627m sets by 2021E. In the medium term, we also forecast the overall smartphone demand to recover, driven by 4G to 5G replacement. We expect total smartphone volumes to increase by an average of 3% over 2021-22-23E, reaching 1.57bn, 1.64bn and 1.68bn smartphones.

Fig 4 Smartphone camera forecast Fig 5 Smartphone demand recovery

(m units) (units per (m units) 3.8 6,000 phone) 4.0 1,800 6% 3.3 3.5 1,700 5% 5,000 2.9 4% 3.0 1,600 2.4 3% 4,000 1,500 2.1 2.2 2.5 2% 3,000 2.0 1,400 1% 1.5 1,300 2,000 0% 1.0 1,200 -1% 1,000 0.5 1,100 -2%

0 - 1,000 -3% 2016 2017 2018 2019E 2020E 2021E 2016 2017 2018 2019E 2020E 2021E 2022E 2023E Total smartphone volumes YoY (RHS) Total lens demand Camera per phone

Source: Macquarie Research, GSMArema, November 2019 Source: Macquarie Research, GSMArema, November 2019

5 November 2019 48 Macquarie Research Global smartphones

Three growth engines Sunny Optical’s revenues come from three reporting segments and four major applications. The three reporting segments are Optoelectronic Products (camera modules), Optical Components (lenses, prism, mirror, filters, etc), and Optical Instruments (microscopes, inspection and detection equipment, etc). The company derives about 86% its revenue from smartphones lens and camera modules, 6% from automotive lenses, 2% from digital camera related products, 1% from optical instruments and 5% from ‘others’, including surveillance cameras. We expect the company’s growth in the next three years to be driven by:

• Increasing multi-camera penetration in Android smartphones and share gains in Samsung to lift ASP and volume growth for camera modules. We forecast a 17% three-year revenue CAGR for the segment.

• Spec upgrades, more cameras per phone and limited competition drive ASP and volume increase for handset lenses. We forecast a three-year revenue CAGR of 32% for the segment.

• Increasing number of sensing cameras per vehicle to drive lens volume increase for Sunny’s automotive lens business. We forecast a 22% three-year revenue CAGR for the segment.

Fig 6 Sunny Optical - revenue forecast by major products

(Rmbm) 50,000

40,000

30,000

20,000

10,000

- 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E Handset camera modules Handset lens set Vehicle lens set Others Source: Company data, Macquarie Research, November 2019

Optoelectronic products The Optoelectronic products business segment is the largest revenue generator for Sunny Optical, accounting for 76% and 75% of 2018 and 1H19 revenues. The company offers a wide range of products in this segment, including handset camera modules, action/ aerial cameras, AR display modules, 3D cameras, gesture control modules, etc. Handset camera modules accounted for 98% of the segment’s revenue in 1H19, or 73% of total revenue, due to the larger market size. Customers in the segment includes top Android smartphone makers such as Huawei, Samsung, Oppo, Vivo and Xiaomi.

Fig 7 Optoelectronic product revenue by application (2013-1H19)

(Rmbm) 20,000 90% 77% 80% 15,000 70% 60% 54% 56% 50% 10,000 39% 40% 27% 30% 5,000 21% 20% 10% 10% - 0% 2013 2014 2015 2016 2017 2018 1H19

Handset camera modules Others Segment growth Source: Company data, Macquarie Research, November 2019 5 November 2019 49 Macquarie Research Global smartphones

Handset camera modules Sunny Optical commenced its handset camera module business in 2003. In 2018 and 1H19, revenue from the handset camera module business represented 74% and 73% of the group’s revenue. Within handset camera module revenue, RGB (colour imaging) cameras accounted for 68% of 1H19 overall revenue, while ToF/ structured light 3D cameras account for about 5% of overall revenue. Handset camera module revenue has been growing at an annualised rate of 36% over 2013 to 2018, reaching Rmb19bn in 2018, driven by specs migration and increasing number of cameras per smartphone.

Fig 8 Handset camera module revenue and segment gross margin

(Rmbm) 13% 25,000 13% 14% 11% 10% 12% 20,000 9.6% 8.4% 10% 15,000 8% 5.9% 10,000 6% 4% 5,000 2%

- 0% 2013 2014 2015 2016 2017 2018 1H19

Handset camera modules Segment gross margin

Source: Company data, Macquarie Research, November 2019

However, gross margin of the module business has been a rollercoaster ride.

• Between 2013 and 2015, there was increasing competition in the domestic market, driving over 20% price erosion for like-for-like product per year and squeezing overall margins from 13% in 2013 to 9.6% in 2015.

• In 2016 and 2017, the adoption of dual cameras in Huawei and other major domestic brands lifted the ASP and gross margin due to: 1) the increased difficulty in packaging of dual cameras; and 2) limited competition. Competitors did not catch up until 2018.

• In 2018, market dynamics evolved. Firstly, competition had caught up and started mass production of dual cameras, squeezing Sunny’s margin premium. Secondly, mid-range smartphones started adopting dual cameras with low-end specs such as pairing 13MP with 2MP or 5MP lenses, while also procuring these cameras individually (lower margin) instead of in one package (higher margin). Thirdly, Sunny started rolling out its production optimisation plan to reconfigure its production line for a higher level of automation and throughput efficiency, which impacted overall utilisation. Finally, the sharp Renminbi movement caused FX loss. As a result, gross margin dropped from 13.5% in 2H17 to 9.4% and 7.5% in 1H18 and 2H18.

• In 1H19, the introduction of 5x optical zoom periscope camera by Huawei’s P30 Pro set a new benchmark for camera photography. However, the periscope-style camera was a new design that required a steep learning curve on module assembly for Sunny. Sunny’s camera module gross margin slid to a historical low of 5.9% due to production yield issues of various new projects. Production optimisation project was still ongoing in 1H19. We expect gross margin to improve in 2H19 on: 1) better production yield of the periscope style camera in P30 Pro; 2) no new periscope-style camera in Mate 30 series, causing margin to plunge (triple and quad cameras with 3x optical zoom instead); 3) multiple triple and quad camera smartphones launched by top Android brands; and 4) production optimisation partially completed, allowing efficiency improvements.

5 November 2019 50 Macquarie Research Global smartphones

Multi-cam adoption driving strong volume growth Sunny’s handset camera module shipments registered a CAGR of 26% over 2013-2018, reaching 423m units in 2018, driven by increasing number of cameras per smartphone and market share consolidation. Year-to-date in 2019 (Jan-Sep) handset camera module shipment volume has increased 23% YoY to about 368m units, on track to reach the company’s target of 20-25% growth. Per Sunny’s monthly disclosure, handset camera module shipment only includes RGB cameras; time-of-flight and structured light 3D cameras are included in Other optoelectronic products with 33.6m unit-shipment in 9M19, up 4.6x YoY. For the overall market, we forecast the number of cameras per smartphone will increase from our estimate of 2.4 units in 2018 to reach 3.8 units by 2021E. For Sunny Optical, we estimate camera module volume shipment will register a CAGR of 19%, from 423m units in 2018 to 708m units in 2021E on triple and quad camera penetration into mid-range smartphones.

Fig 9 Handset camera module shipment and growth Fig 10 Other optoelectronic products’ monthly shipment

(m units) (m units) 800 45% 6 700%

40% 700 5 600% 35% 600 500% 4 30% 500 400% 25% 3 400 300% 20% 2 300 200% 15% 1 200 100% 10%

100 5% 0 0%

- 0% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Shipment YoY (RHS) Other optoelectronic products YoY (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Fig 11 Handset camera module monthly shipment (Jan 16 – Aug 19)

(m units) 60 160% 140% 50 120% 40 100% 80% 30 60% 40% 20 20% 10 0% -20% 0 -40%

Handset camera modules YoY (RHS)

Source: Company data, Macquarie Research, November 2019

5 November 2019 51 Macquarie Research Global smartphones

Resolution mix improving Camera resolution migration used to happen about every two to three years. Year 2007 to 2010 was for 5MP migration; 8MP upgrade happened between 2011 and 2013; 13-16MP upgrade happened between 2014 and 2017; 20-24MP upgrade in 2018. In 2019, camera resolution has been increasing faster than in previous cycles. 48MP main cameras were adopted in flagship smartphones in 1H19, followed by a 64MP upgrade in 2H19. However, the number of 2-8MP lenses has also increased as supporting lenses in multi-camera systems.

Fig 12 Handset camera module volume mix Fig 13 Handset camera modules ASP and growth

(Rmb) 100% 60 40% 4% 4% 6% 7% 8% 54 90% 16% 6% 17% 17% 20% 13% 11% 9% 49 49 31% 50 46 30% 80% 45 41 25% 70% 23% 33% 31% 40 35 20% 52% 39% 42% 34 60% 20% 31 50% 30 10% 22% 14% 40% 79% 22% 10% 9% 20 0% 30% 59% 19% 19% 49% 21% 17% 15% 20% 16% 10 -10% 10% 20% 18% 17% 15% 12% 16% 0% 0 -20% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Below 8MP 8MP 10-20MP Above 20MP Dual cam Triple/Quad cam ASP YoY (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

In our resolution mix forecast, we have:

• Dual-cam and triple/quad cameras as about 15-20% of the product mix for 2019-20-21E. We don’t forecast an increasing mix as we believe mid-range multi-cam systems would procure individual cameras instead of shipping out as one set.

• The increasing mix of 20MP cameras to reflect resolution migration of the main camera of multi- cam system (cameras procured separately, not in a set).

• 8MP and below cameras still represent about 30-35% of the mix. Most of the telephoto lenses use 8MP and depth-sensing lenses uses 2MP or 5MP resolution.

Mild ASP increase, depending on the mix It’s becoming increasingly difficult to forecast product mix and ASP, with the complexity of multi- camera design and procurement method. Factoring specs upgrades like telephoto, wider aperture, wide-angle view, we are modelling overall camera module ASP to increase by 9% in 2019 to Rmb49.1 and stay flattish in 2020 to Rmb49.3. We forecast ASP to decline by -6% to Rmb46.2 in 2021, based on the previous dual-camera cycle that mid-range cameras tend to have less specs upgrades.

Camera module capacity to increase by 15% 2018 year-end monthly capacity for camera modules reached 65m units and the company expects to enlarge capacity to 75m per month in 2H19 through production line optimisation. The company has increased its capex budget for the business segment from Rmb700m-800m to Rmb1bn after the interim result announcement, accounting for 25% of the 2019 capex plan.

5 November 2019 52 Macquarie Research Global smartphones

Optical components The Optical component business segment accounts for 23% and 24% of 2018 and 1H19 revenues, but 64% and 73% of gross profit for the same period. The company offers a wide range of products in this segment, including lenses for various applications, such as handset lenses, vehicle lenses, surveillance lenses, action/aerial camera lenses, Fresnel lenses for VR headsets, optical components for head-up display (HUD) and Lidar for car, and other optical components such as prisms, mirror and IR filter. The two major revenue contributors in this segment are handset lenses and vehicle lenses, which accounted for 54% and 27% of the segment’s revenue in 1H19.

Fig 14 Optical component revenue by application Fig 15 Optical components drive majority of GP growth

(Rmbm) (Rmbm) 14,000 16,000 62% 70% 14,000 60% 12,000 12,000 46% 45% 50% 10,000 40% 10,000 34% 40% 8,000 8,000 30% 30% 30% 6,000 6,000 21% 20% 4,000 4,000

2,000 10% 2,000 - 0% - 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 2013 2014 2015 2016 2017 2018 2019E2020E2021E

Handset lens Vehicle lens Optical components Optoelectronic products Optical Instruments Others Segment growth

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Handset lens Sunny Optical commenced its handset lens production since 2004. In 1H19, handset lenses accounted for 54% of the optical component segment’s revenue, or 13% of the group’s revenue. Sunny’s handset lens revenue recorded a CAGR of 99% over 2013 to 2018. End-customers in the segment include top Android smartphone OEMs like Samsung, Huawei, Oppo, Vivo and Xiaomi, Sunny’s camera module division (market price), and other camera module makers supplying to these OEMs such as O-Film, LuxVision and Q Tech.

Konica Minolta agreement helped set the stage By the end of 2013, Sunny optical had accumulated 10 years of handset lens design and production know-how with 8MP lenses in mass production and completed R&D on ultra-thin 8MP and 13MP lenses. On 31 December 2013, Sunny Optical signed a strategic cooperation agreement with Konica Minolta, which allowed the company to gain access to Konica Minolta’s patents, machineries and software and production technical support for a consideration of Rmb12m. With Konica’s technical support, Sunny was able to de-bottleneck design and yield issues. By end of 2014, Sunny’s handset lens shipment increased by 117% YoY to 120m sets and increased by another 1.5x to 302m sets in 2015.

Sunny’s continued innovation propels growth Since then, Sunny has continued with product R&D and production improvements. The following chart overlays Sunny’s progress in product R&D and mass production with monthly shipment volumes. Sunny’s handset lens shipment recorded a CAGR of 77% over 2013-2018. We estimate Sunny’s global market share increased from below 5% in 2013 to about 26% in 2018, making it a leading lens provider for Samsung and gaining domestic market share in mid-range to high-end smartphones.

5 November 2019 53 Macquarie Research Global smartphones

Fig 16 Sunny’s handset lens shipment; mass production and R&D completion timeline

(m units) MP:16MP ulltrawide; 140 MP: 32MP; 48MP; 7P ultra thin MP: 16mp R&D: 7P f/1.4 R&D: 64MP 120 f/1.65; 20MP; MP: 16MP hybrid lens; 100 wide R&D: 7P MP: 13- aperture; 80 16MP R&D: 10MP+ 6P Konica Minolta: 23MP patents & 60 production know how 40

Jul14 Jul15

Jul 16 Jul 17 Jul 19 Jul Jul 18 Jul

Jan14 Jan15 Jan16

Mar14 Mar15 Mar16

Nov14 Nov15

Sep14 Sep15

May14 May15

Jan 17 Jan Jan 18 Jan 19 Jan

Mar 17 Mar 19 Mar Mar Mar 18

Nov 16 Nov 17 Nov Nov 18 Nov

Sep 16 Sep 17 Sep Sep 18 Sep

May 17 May 19 May May 16 May 18 May Handset lens

Source: Company data, Macquarie Research, November 2019

Improving product mix, ASP and gross margin Sunny’s handset lens product mix were mainly below 8MP product before 2016, and product mix has been improving with increasing mix of 13MP and above lenses. In 1H19, the company disclosed that 10MP and above lenses reached 52% of the mix, and in this, 20MP and above lenses reached 13.7% of the total mix. The company also saw ASP of approximately 10% in 1H19 on mix improvement. We expect product mix migration to continue with the accelerated pixel migration of leading flagship smartphones in 2H19. We forecast Sunny’s handset lens ASP to increase from approximately Rmb4.3 in 2018 to Rmb4.9 in 2019, Rmb5.6 in 2020, and Rmb6.9 in 2021.

Fig 17 Handset camera module volume mix Fig 18 Handset camera modules ASP and growth

(Rmb) 100% 2% 8.0 30% 9% 4% 7% 9% 6.9 90% 16% 20% 7.0 25% 8% 29% 26% 80% 45% 6.0 5.6 20% 43% 40% 70% 4.9 5.0 15% 38% 4.3 60% 20% 3.9 3.7 3.9 39% 4.0 3.6 10% 50% 3.2 91% 18% 18% 3.0 5% 40% 83% 78% 17% 35% 2.0 0% 30% 11% 51% 20% 1.0 -5% 34% 35% 30% 9% 10% 24% - -10% 11% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 0% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E Handset lens ASP YoY (RHS) Below 8MP 8MP 10-20MP Above 20MP

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Sunny’s handset lens gross margin has been increasing steadily, from about 30% in 2013 to our estimate of 48% in 1H19 (the company guides 45-50%), on product mix improvement and limited competition in the high-end market. We expect Sunny’s handset lens gross margin to continue to improve, reaching 48%, 50% and 51% in 2019-20-21E. Sunny’s handset lens business accounted for 36% of the group’s gross profit in 2018 and we expect the increasing profitability in this segment to drive gross profit contribution to 40% by 2021.

5 November 2019 54 Macquarie Research Global smartphones

Fig 19 Handset lens gross margin (estimates) and gross profit contribution

55% 45% 51% 50% 40% 50% 48% 46% 35% 45% 43% 30% 39% 40% 25% 34% 35% 33% 20% 30% 15% 30% 10% 25% 5% 20% 0% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E % of Sunny's total gross profit (RHS) Handset lens gross margin (estimates)

Source: Company data, Macquarie Research, November 2019

Capacity expansion Company has been aggressively increasing capacity in the past few years, from 40m set per month in 2016 to 70m sets in 2017 and 120m sets in 2018. With the increasing number of lenses per smartphone going forward, the company plans to further expand monthly capacity to 150m sets by end of 2019. About 50% of the capex budgeted in 2019 or Rmb2bn would be allocated to handset lens capacity expansion, an increase of 67% YoY. Sunny’s peer Largan mentioned in its recent conference call that its new factories will only be built in 2023, while near-term capacity reaches bottleneck. With the increasing demand for high-end lenses in the market, we expect Sunny to benefit from Largan’s capacity tightness. Sunny has ongoing plan to expand Phase Two and Phase Three of the new production base.

Vehicle lenses Sunny Optical commenced its vehicle lens production in 2004 and is the world’s largest vehicle lens provider specialising in ADAS lenses with an estimated 27-28% market share in 2018, per Sunny. Vehicle lenses for ADAS applications accounted for over 50% of Sunny’s shipment mix in 2018.

Fig 20 Sunny’s vehicle lens set products

Source: Company data, November 2019

5 November 2019 55 Macquarie Research Global smartphones

The company targets to gain market share by technology leadership and reasonable pricing. In 1H19, vehicle lenses accounted for 27% of the optical component segment’s revenue, or 6% of the group’s revenue. Sunny’s vehicle lens revenue recorded a CAGR of 44% over 2013 to 2018 on the trend of increasing cameras per car, increasing ADAS lens in product mix and market share consolidation. End-customers in the segment include global tier-one companies such as Autoliv, Bosch, Continental, Delphi and Magna.

Fig 21 Vehicle lens revenue and gross margin Fig 22 Vehicle lens shipment and ASP

(Rmbm) (m units) (Rmb) 3,500 44% 44% 44% 45% 80 50 44% 44% 70 3,000 45 42% 43% 60 2,500 41% 42% 40 41% 50 2,000 40% 40% 40 35 1,500 38% 38% 39% 30 30 1,000 38% 20 37% 500 25 36% 10 - 35% 0 20 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Vehicle lens revenue Gross margin (estimate) Vehicle lens shipment ASP

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Sunny’s vehicle lens shipments grew rapidly, at a CAGR of 35% over 2013-2018, on the increasing number of cameras per car due to ADAS adoption. However, with the automobile industry slowdown in 2018, shipment growth also slowed down from 41% YoY in 2017 to 25% YoY. The company expects volumes to increase 25% YoY in 2019; YTD shipments (Jan to Sep) are on-track to meet the company’s target. We forecast shipments to register average annual growth of 20% over 2019-20-21E. ASP of vehicle lenses recorded a CAGR of 7% from 2013 to 2018, on the increasing mix of high- ASP ADAS lenses. In 2018 and 1H19, vehicle ASP reached Rmb44.3 and Rmb44.7. The price range of Sunny’s products is between US$5-US$10 per set, and Sunny is keen on maintaining a stable ASP range as it targets to gain market share via better technology offerings than peers. We forecast ASP to be stable, with a slight increase of 1.8% per year over 2019-20-21E. As such, we forecast vehicle lens revenue to reach Rmb2.19bn in 2019, Rmb2.67bn in 2020, and Rmb3.25bn in 2021, with gross margin stable at about 44%.

Fig 23 Vehicle lens business contribution to sales and gross profit

8% 45% 7% 7% 7% 6% 40% 7% 6% 6% 6% 35% 6% 5% 5% 30% 5% 25% 4% 20% 3% 15% 2% 10% 1% 5% 0% 0% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E % of gross profit contribution (RHS) % of sales contribution

Source: Company data, Macquarie Research, November 2019

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Diversifying to other optical components in cars Besides lens sets for front view, surround view, back-view, in-cabin view and sensing, the company also offers various head-up display (HUD) solutions, including key optical components like projector lens, freeform optics, collimators, fly’s eye lens array and flat mirror; various Lidar solutions, including key optical components like spherical glass lens, aspherical glass lens, aspherical plastic lens and cylinder /acylinder lens; and vehicle camera module.

Fig 24 Sunny’s product coverage in automobile segment

Source: Company data, November 2019

Sunny diversified into vehicle camera modules in 2018 and commenced mass production of auto camera module for Denso, a Japanese tier-one customer, in 1H18. Previously, Sunny had no intention to produce vehicle camera modules, because its tier-one customers have enough capacity. However, with the improvement of ADAS algorithm, the software system is able to compute more information input from the cameras. As such, there’s increasing demand for higher resolution cameras modules; for example, upgrading from VGA to 2MP in surrounding cameras. Per Sunny Optical, some of their Tier-one customers prefer to outsource the camera module assembly to tier-two suppliers instead of increasing internal capacity. Therefore, Sunny now also offers modules solution, besides lenses. In the pipeline, Sunny has already sent 4/8MP front camera module samples to customers for qualification.

5 November 2019 57 Macquarie Research Global smartphones

R&D R&D has always been a core focus of the company to develop and improve product portfolio. Sunny’s R&D spending has reached a five-year CAGR of 40%, outpacing its revenue CAGR of 35%, over 2013-2018. The company increased R&D expense ratio from 4.3% in 2013 to 5.3% in 2018, and expects to keep R&D spending above 5% going forward. As a result of increasing R&D effort, Sunny’s patent portfolio has grown to 1,263 patents in 1H19, up from 239 patents five years ago in 2014.

Fig 25 Sunny’s enlarging patent portfolio Fig 26 R&D spending and R&D as % of sales

(Rmbm) 1,400 3,000 6.0% 5.5% 5.5%5.5%5.5% 1,200 2,500 5.2% 5.2%5.3% 5.5%

1,000 4.8% 2,000 4.7%4.7% 5.0%

800 1,500 4.3% 4.5% 4.1%

600 1,000 4.0%

400 500 3.5%

200 - 3.0% 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19

Number of patents New patents added R&D % of sales

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Latest R&D achievements in 2018-1H19 The following table summarises Sunny’s R&D achievements in 2018 and 1H19. Besides products, Sunny also continuously improves manufacturing technologies. In 1H19, the company completed R&D on its third-generation active alignment machine, to smoothly integrate it with the production line for higher accuracy and efficiency for high-resolution products and multiple camera module assembly. The company completed R&D of on-line assembly production line, which allows full automated production from chip on board to the active alignment process. Sunny also launched its ultra-thin semiconductor packaging technology (IOM) to further miniaturise product form factor and to improve the product’s precision and durability.

Fig 27 Summary of Sunny’s latest R&D and product achievements in 2018-1H19 Completed R&D Commenced mass production

Handset camera module - High-accuracy ToF products with wide angle - 5x optical zoom periscope-style modules - Linear ToF products - f/1.4 ultra-large aperture modules Handset lens - 64MP large image size and ultra-macro shooting lens set -16MP ultrawide angle (120 degrees) lenses - ultra-miniaturised head lenses, 32MP miniaturised head lenses - 7P f/1.4 ultra-large aperture lenses, 7P with variable aperture - 16MP ultra-thin lenses, 48MP lenses Vehicle camera - 8MP front-view ADAS vehicle camera modules - 2MP and above ADAS vehicle lens set - 8MP vehicle lens set - Optical component of vehicle Lidar - Surround view, front view, in-cabin vehicle camera modules (some achieved mass production) Optical instruments - China’s first IoT based microscopic interactive teaching - Fully automated research and inverted microscopes system - Scanning detection equipment for anisotropic conduction - 10-person view microscope film - Pathological slice scanning image analysis system - Mycobacterium tuberculosis microscopy scanning system Source: Company data, Macquarie Research, November 2019

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Competition Our discussion on competition will be focused on the smartphone market and vehicle camera market, which account for the majority of Sunny’s revenue.

Camera module market in China The camera module assembly market in China has been very competitive, with relatively lower entry barriers compared to the other components of camera modules. It’s a crowded market with plenty of players including Sunny, LuxVision, Semco, O-Film, Q Tech, Truly, Primax, Holitech and other smaller low-end players, mainly serving Android customers. Sunny Optical positions itself as a high-end smartphone camera module maker with leading market shares in flagship projects. To maintain its market position, Sunny’s strategy is to continuously invest in R&D on both product design and manufacturing. Sunny demonstrated its tech leadership in 2017, with several quarters of dual-camera packaging leadership leading to recent-year record high camera module gross margin of 13.1%. In 1H19, Sunny had leading market share in the periscope style triple-camera of Huawei’s P30 Pro. We rank the camera module players by technology capability as follows:

• First-tier: Sunny Optical, LuxVision, Semco (selective projects) • Second-tier: O-Film, Q Tech (catching up quickly in the Huawei supply chain)

• Third-tier: Truly, Holitech • Niche: Primax (investing less and de-emphasising the camera module business) In terms of scale, O-Film is the leader in China and global markets, with volumes reaching 551m units in 2018, serving both Apple and Chinese Android customers. Sunny ranks second with 423m units in 2018. However, Sunny has better product mix with above 10MP modules including multi- cameras accounting for 73% in shipment in 2018, compared to 49% of O-Film.

Fig 28 Camera module shipment comparison Fig 29 Camera module mix comparison (2018)

(m units) 600 551 100% 500 90% 500 80% 43% 423 49% 70% 400 73% 325 60% 300 292 300 270 264 50% 228 200 215 40% 187 183 200 177 173 133 30% 57% 102 51% 83 98 20% 100 48 27% 25 10% - 0% 2013 2014 2015 2016 2017 2018 1H19 Sunny O-Film Q Tech

Sunny O-Film Q Tech Below 10MP Above 10MP + multi-cam

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Pricing competition Price erosion reaches over 20% for like-for-like products; to improve or maintain stable ASP, camera module makers must improve their product mix by providing advanced manufacturing technology and product upgrade to keep up with customers’ camera technology migration. We expect pricing competition to ease going forward. One example of this is O-Film: before 2019, O-Film used to be very aggressive in capacity expansion and to gain volume share gain via pricing competition. In 2018, O-Film’s free cash generation weakened due to aggressive capital expenditure, gearing ratio heightened and incurred an asset write-off of Rmb1.84bn on weak accounting and internal control. O-film made a net loss of Rmb419m in 2018. To turn around, the company, in 2019, decided to improve cash flow generation with prudent capex of less than Rmb2bn and focus on quality growth rather than competing on price for volume share gain.

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Gross margin comparison Gross margins of the companies—Sunny Optical, O-Film and Q Tech—are harder to compare, on account of various company-specific challenges and strategies.

• In 2017, the overall industry’s gross margin expanded YoY due to adoption of dual cameras. • In 2018, gross margin declined due to: 1) dual cameras being procured separately; and 2) sharp Renminbi depreciation.

 For Sunny, the process of production line optimisation had held up capacity and caused inefficiency in production.

 For Q Tech, its strategy to gain market share in Huawei caused the low-end product mix to increase, lowering the overall margin.

• In 1H19:  Sunny had yield issues with the periscope style and various new projects.

 Q Tech’s gross margin improved due to product mix recovery.  O-Film’s gross margin had always been higher than its peers’, despite inferior product mix; we think this could be due to the classification of expenses between COGS and OPEX. In 1H19, O-Film’s gross margin took a hit compared to 2018 due to weak iPhone seasonality.

Fig 30 Camera module gross margin by company Fig 31 Camera module ASP by company

(Rmb) 19% 60 55 17% 50 15% 45

13% 40 35 11% 30

9% 25 20 7% 15 5% 10 2013 2014 2015 2016 2017 2018 1H19 2013 2014 2015 2016 2017 2018 1H19

Sunny O-Film Q Tech Sunny O-Film Q Tech

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Below we compare camera module operational data and strategies at Sunny, O-Film and Q Tech.

Fig 32 Camera module peer comparison 1H19 Sunny Optical O-Film Q Tech

Sales (Rmb m) Rmb11,396m Rmb14,270m Rmb3,917m Gross margin 5.9% 9.18% 7.60% Shipment mix 10MP and above (1H19): 64.7% 10MP and above (2018): 49% 10MP and above (1H19): 47% Production of periscope cameras 10MP and above (2018): 43% 10MP and above (2018): 73% Sales mix (estimates) 10MP and above and multi-cam 10MP and above and multi-cam reached 10MP and above and multi-cam reached 90% of segment revenue 70% of segment revenue reached 70-80% of segment revenue ASP (Rmb) Rmb 49.2 Rmb 48.8 Rmb 21.5 Monthly capacity (Year-end) 2019: 75m 2018: 14m for Apple 2019: 50m 2018: : 65m 2018: 65m for Android 2018: 35m Shipment volume (m units) 1H19: 215m 1H19: 292m 1H19: 183m 2018: 423m 2018: 551m 2018: 264m Top customers Top Android brands Apple and top Android brands Huawei, Oppo, Vivo Strategy and objective Maintain share in high-end/ premium Less aggressive in volumes and share gain; Target to gain share in Huawei’s high- smartphones through technology prudent in cash spending; end projects leadership let go of low-end and focus on high-end market Source: Company data, Macquarie Research, November 2019

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Smartphone camera lens duopoly The smartphone camera lens market has always been less competitive compared to the camera module business due to relatively higher entry barriers. Product design, mould design, material composition and production know-how are all proprietary core competencies of lens makers. With ongoing cameras resolution migration and specs upgrade, Companies with strong capabilities consolidates market share, while the laggards struggle to catch up. We view the current competitive landscape as a strong duopoly between Largan and Sunny; Largan has larger share in high-end/ premium smartphone, while Sunny dominates the mid-range market but gaining share in high-end smartphones.

Fig 33 Largan vs Sunny Optical 1H19 Largan Sunny Optical

Sales (m) US$797 US$388 (Total volume x ASP) Gross margin 67% 45%-50% Shipment mix 10-20MP: 50-60% 10-20MP: 38% 20MP+: 20-30% 20MP+: 14% ASP US$1.2 US$0.7 Monthly capacity estimates 170m 150m Smartphone market share (2018 estimates) 35-40% 25-30% Top customers Apple, Huawei, Chinese brands Samsung, Chinese brands Addressable market(s) Smartphone Smartphone, automotive, IoT, industrial equipment Strategy and objective Technology leadership and Market share gain through profitability technology advancement and profitability Source: Company data, Macquarie Research, November 2019

Largan and Sunny have similar scale today but product mix / ASP gap still wide In Fig 35 below, we compared Sunny Optical’s reported monthly smartphone lens shipments with our Largan estimates. We calculate Largan’s monthly shipment by dividing the reported monthly revenue by our ASP forecasts. In 2016, Sunny’s shipments were a third of Largan’s, but quickly caught up to 50%, 70% and 86% of Largan’s scale in 2017, 2018 and 1H19, due to growing market share in Samsung and Chinese smartphone market on technology improvements. However, Sunny’s product mix is still inferior to Largan’s. Largan’s high-resolution product mix (10MP and above) reached over 70%, while Sunny’s high resolution lenses were about 52% of mix in 1H19. This explains why: 1) our Largan ASP estimate of US$1.22 is 70% higher than Sunny’s ASP of US$0.7 in 1H19; and 2) about 20% gross margin gap between the two.

Fig 34 Shipment volume comparison (Jan 2016 to Sep 2019) Fig 35 Product mix comparison (1H19)

(m units) Monthly shipment 1H19 shipment mix 180 100% 14% 160 90% 20-30% 140 80% 120 70% 38% 100 60% 80 50% 50-60% 60 40% 16% 40 30% 20 20% 10-20% 32% 0 10% 0-10%

Jul-17 Jul-19 Jul-18

Jul-16 Largan Sunny

Jan-16 Jan-17 Jan-18 Jan-19

Mar-16 Mar-18 Mar-19 Mar-17

Sep-16 Nov-16 Sep-17 Sep-18 Nov-18 Nov-17 Sep-19

May-16 May-17 May-19 May-18 Largan Sunny Below 8MP 8MP 10-20MP Above 20MP

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

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Fig 36 Largan’s and Sunny's smartphone lens ASP estimates

(US$) 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 - 2016 2017 2018 1H19

Largan (ex-VCM) Sunny

Source: Company data, Macquarie Research, November 2019

A healthy duopoly In the following figures, we have adjusted Largan’s revenue and margin to exclude VCM sales. While Fig 34 shows that Sunny’s volumes have been catching up with Largan’s, Fig 38 shows that the gross margins of the two players have actually been steadily increasing (instead of the declining trend we see in camera module and other competitive markets). We believe this is due to the healthy competitive dynamics between the two companies. Largan’s key priorities are technology leadership, innovation and sustainable profits; while Sunny understands the uniqueness of smartphone lens market with continuous innovation with little competition. Hence, Sunny’s key strategy is to gain volume share via R&D and technology improvement, while following Largan’s pricing to maximise profits. Therefore, there’s less margin downside risk in smartphone lenses, and margin upside comes from product mix improvement and customer’s camera upgrade roadmap.

Fig 37 Revenue comparison of Largan and Sunny Fig 38 Gross margin comparison

(US$m) Smartphone lens revenue smartphone lens gross margin 2,000 80%

1,800 70% 1,600 60% 1,400 50% 1,200 1,000 40% 800 30%

600 20% 400 10% 200 0% - 2013 2014 2015 2016 2017 2018 1H19 2013 2014 2015 2016 2017 2018 1H19 Largan (ex-VCM) Sunny (external) Sunny (external + internal)* Largan (ex-VCM) Sunny

Source: Company Data, *Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

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Technology leader in vehicle lenses Sunny Optical positions itself as a tier-two global supplier of vehicle lens sets, specialising in lenses used in ADAS. Peers in the supply chain include Hitachi Maxell, O-Film (Fujifilm’s China factory), Sekonix and Nidec. Sunny estimates its market share in the vehicle lens industry reached 26-27% in 2018, maintaining its market leadership in the past several years. Automotive industry has high-entry barrier due to the following reasons:

• Lengthy product qualification time: it could take takes five to ten years to qualify a product, depending on the customer;

• Single-sourcing policy for camera lenses in the industry, one supplier for each lens; • High supplier stickiness: once a supplier gains qualification of a certain car model, the supplier relationship would last for the entire generation of the product cycle, which generally lasts for 6- 8 years. There’s little incentive for the customer to switch suppliers with pricing discounts; suppliers gain market share by technology advancements.

Sunny Optical’s strategy in this industry is to continue gaining market share by: 1) providing industry-leading lens systems; and 2) encouraging customer adoption by maintaining price range at US$5-10 per set and earning a stable margin.

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Initiate coverage with Outperform

Financial forecast Sunny’s revenue growth slowed down in 2018, due to increasing competition in dual-camera, less specs upgrade in mid-range smartphones, and separation of dual-camera packaging into two modules. In 2019, we expect triple and quad cameras with specs upgrades in high-end and flagship smartphones to drive volume demand. We forecast gross margin will recover HoH in 2H19 after the company went through production learning curve and challenges of various new products including periscope-style cameras. We forecast three-year revenue CAGR of 25% (Rmb36.57bn in 2019, Rmb43.83bn in 2020, and Rmb50.43bn in 2021).

Fig 39 Revenue and growth forecasts Fig 40 Gross profit composition and margin

(Rmbm) (Rmbm) 50,000 60% 10,000 26%

45,000 9,000 24% 50% 40,000 8,000 22% 35,000 7,000 40% 6,000 20% 30,000 5,000 18% 25,000 30% 4,000 16% 20,000 3,000 20% 14% 15,000 2,000 10,000 12% 10% 1,000 5,000 - 10% 2013 2014 2015 2016 2017 2018 2019E2020E2021E - 0% 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E Optical components Optoelectronic products

Revenue YoY (RHS) Optical Instruments Gross margin (RHS)

Source: Company Data, *Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Revenue to growth We forecast Sunny’s revenue to grow 41% in 2019, 20% in 2020 and 15% in 2021.

• Camera module revenue to increase at a three-year CAGR of 19%, reaching Rmb25.2bn in 2019, Rmb29.5bn in 2020 and Rmb32.0bn in 2021, with gross margin steadily recovering from 8.4% in 2018 to 7.1% in 2019E, 8.7% in 2020E and 8.6% in 2021E.

• Handset revenue to increase by a three-year CAGR of 32%, reaching Rmb5.29bn in 2019E, Rmb6.58bn in 2020E and Rmb9.41bn in 2021E, with gross margin reaching over 50% by 2021E.

• Vehicle lens revenue to increase by a three-year CAGR of 22%, reaching Rmb2.19bn in 2019E, Rmb2.67bn in 2020E and Rmb3.25bn in 2021E, with stable gross margin of about 44%.

Fig 41 Revenue by product lines

(Rmbm) 50,000

40,000

30,000

20,000

10,000

- 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E Handset camera modules Handset lens set Vehicle lens set Others

Source: Company data, Macquarie Research, November 2019

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Operating leverage driven by improving product mix The company aims to keep the opex ratio at 8-8.5% and has been below or within the target in the past five years. The R&D ratio has been steadily growing, from below 5% before 2017 to 5.2-5.3% in 2017-18; we expect the company to spend 5.5% of sales on R&D in our forecast periods. We forecast opex to be steady at about 8.1% over the next three years. With gross margin improving on increasing gross profit contribution from better handset lens mix, we are expecting to see operating leverage, with operating margin increasing from 11% in 2018 to 16% in 2021E.

Fig 42 Operating income and margin Fig 43 R&D expense and ratio

(Rmbm) (Rmbm) 9,000 18% 3,000 6.0% 8,000 16% 2,500 5.5% 7,000 14% 6,000 12% 2,000 5.0% 5,000 10% 1,500 4.5% 4,000 8% 3,000 6% 1,000 4.0% 2,000 4% 500 3.5% 1,000 2% 0 0% - 3.0%

Operating income OP margin R&D % of sales

Source: Company Data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Sunny’s net debt to equity ratio has risen to 33% in 2018 due to the five-year US$600m bond issued in January 2018. The main reason for the company to raise US dollar bonds was to expand financing channels outside of China for any future capacity expansion needs, which had lower interest rates at the time of issuance but was also more efficient in general. The company generated positive free cashflow from 2015 to 2018. Sunny generated negative free cashflow in 1H19 due to the plunging gross margin of the camera module business on product yield challenges. Sunny has almost doubled its capex budget YoY in 2019. We expect the camera module segment margin to recover in 2H19 and the company back to positive free cashflow in 2020.

Fig 44 Cash position Fig 45 Free cashflow

(Rmbm) (Rmbm) 5,000 60% 9,000

4,000 40% 7,000

3,000 20% 5,000

3,000 2,000 0% 1,000 1,000 -20% (1,000)

- -40% (3,000)

(1,000) -60% (5,000)

Net debt (cash) Net debt/ equity (RHS) Operating cashflow Capex Free cashflow

Source: Company Data, *Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 65 Macquarie Research Global smartphones

Capex The company’s capex increased rapidly YoY from 2016 onward, due to: 1) the increasing capacity requirement on the multi-camera trend; 2) expansion of production base; and 3) increasing precision and efficiency requirements leading to its production line optimisation plan. As a result, the capex to revenue ratio has also spiked, to about 11% in 2019. We expect capex in 2020 will continue to be heightened due to the increasing penetration of triple/quad cameras in smartphones, requiring higher capacity for modules and lenses. The company’s net fixed asset turns peaked in 2017 at 10.2x due to limited additional capex needed for single cameras and high-end dual cameras. In 2018, Sunny continued to increase capacity and invested in new equipment for camera modules, but revenues were impacted as dual-camera pricing premium was squeezed. . We expect net fixed asset turns will continue to trend down to about 5x as the company continues to expand capacity.

Fig 46 Capex and capex % of revenue Fig 47 Net fixed asset turns

(Rmbm) (x) 4,500 12% 12 4,000 11% 10 3,500 10% 3,000 9% 8 2,500 8% 6 2,000 7% 1,500 6% 4 1,000 5% 2 500 4% - 3% -

Capex Capex % of revenue Net fixed asset turnover

Source: Company Data, *Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Dividend policy The company has been distributing 25% of net profit to shareholders since 2016, and we don’t expect any changes in the future. We expect dividend per share to rise from Rmb0.6 per share in 2018 to Rmb0.8 per share 2019, on increasing net income.

ROE and ROIC ROE and ROIC spiked in 2017 due to the exceptional dual-camera gross margin, with limited pricing competition due to technology leadership. In general, ROE and ROIC trend up for Sunny as the company improves profitability.

Fig 48 Dividend and payout Fig 49 ROE and ROIC

(Rmb) 1.8 35% 50% 45% 1.6 30% 1.4 40% 25% 35% 1.2 30% 1.0 20% 25% 0.8 15% 20% 0.6 15% 10% 0.4 10% 5% 0.2 5% 0% - 0%

DPS Dividend payout ROE ROIC

Source: Company data, *Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 66 Macquarie Research Global smartphones

Valuation We initiate with Outperform rating and a 12-month target price of HK$163.56, based on 30x 2020E EPS. Our valuation multiple is higher than the average of the past 12-month forward PE of 24x, as we see re-rating upside on gross margin recovery.

Downside risks The US-China trade tensions have brought an increased level of uncertainty for end-user demand outside China. It is uncertain whether consumers will keep purchasing Huawei’s smartphones without access to Google Mobile Services. Market share shuffling between Android brands is likely to have limited impact on Sunny Optical, in our view, given its wide coverage of customers domestically and outside China. Potential downside risks to our forecasts include slowdown in specs upgrade and increasing competition, which could hurt pricing and margins.

Fig 50 Valuation comparison 3M Stock Company Ticker Mkt cap ADTO Price performance TP Upside Rec EPS Growth PE PB ROE (US$m) (US$m) (lcy) 1M 1Y (lcy) 2019E 2020E 2019E 2020E 2019E 2020E 2019E 2020E

Largan 3008 TT 19,640 91 4,460.0 -2% 34% 5,000.0 12% O 20% 17% 20.8 17.8 4.7 4.0 25% 24% Sunny 2382 HK 18,108 103 129.4 12% 77% 163.56 26% O 37% 54% 37.5 24.3 10.5 7.7 32% 37% AAC 2018 HK 7,940 54 51.5 24% -20% 52.20 1% N -47% 38% 28.0 20.2 2.9 2.7 11% 14% O-Film* 002456 CH 4,336 234 11.2 -5% -14% NR -275% 84% 33.2 18.1 3.0 2.7 10% 13% Q Tech 1478 HK 1,533 9 10.5 24% 164% 12.90 23% O 2850% 49% 25.3 17.0 4.2 3.5 18% 22% Genius* 3406 TT 1,480 159 447.0 1% 103% NR 117% 57% 22.2 14.2 4.9 3.9 25% 31% Sekonix* 053450 KS 70 1 6,960.0 0% 11% NR -620% 5% 8.0 7.6 0.6 0.6 8% 8% Average 8% 51% 297% 44% 25.0 17.0 4.4 3.6 18% 21% Source: *Bloomberg Consensus, Macquarie Research, November 2019

Fig 51 PE bands Fig 52 PB bands and ROE

Rmb Rmb 180 180 45% 160 160 40% 140 140 120 120 35% 100 100 30% 80 80 60 25% 60 40 40 20% 20 20 0 15%

Feb-18 Feb-19 Feb-16 Feb-17

Nov-15 Nov-16 Nov-18 Nov-17

Aug-15 Aug-17 Aug-19 Aug-16 Aug-18

May-15 May-16 May-18 May-19 May-17

Feb-16 Feb-17 Feb-18 Feb-19

Aug-16 Nov-17 Aug-18 Nov-18 Aug-19 Aug-15 Nov-15 Nov-16 Aug-17

May-15 May-16 May-18 May-19 May-17 Price 3x 5x Price 12x 18x 7x 9x 11x ROE (RHS) 24x 30x 36x

Source: Bloomberg, Macquarie Research, November 2019 Source: Bloomberg, Macquarie Research, November 2019

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Fig 53 Sunny Optical model summary 2017 2018 2019E 2020E 2021E

Camera module Shipment (m units) 325 423 514 600 708 ASP (Rmb) 41.1 53.6 49.1 49.3 46.2 Gross margin 13% 8.4% 7.1% 8.7% 8.6%

Handset lens set Shipment (m units) 608 951 1,240 1,499 1,758 ASP (Rmb) 3.9 4.3 4.9 5.6 6.9 Gross margin 46% 43% 48% 50% 52%

Vehicle lens set Shipment (m units) 32 40 48 58 70 ASP (Rmb) 43 44 45 46 47 Gross margin 44% 42% 44% 44% 44% Source: Company data, Macquarie Research, November 2019

Fig 54 Our estimates vs consensus 2019E 2020E 2021E Rmb m MQ Consensus Diff MQ Consensus Diff MQ Consensus Diff

Revenue 36,572 34,779 5% 43,833 42,522 3% 50,431 50,232 0% Gross profit 7,033 6,674 5% 9,710 8,745 11% 12,325 10,679 15% OP profit 4,074 3,971 3% 6,166 5,511 12% 8,248 7,098 16% PBT 3,903 3,910 0% 5,966 5,326 12% 8,254 6,659 24% Net income 3,403 3,429 -1% 5,252 4,699 12% 7,241 5,896 23% Margin Gross margin 19.2% 19.2% 0.1 ppts 22.2% 20.6% 1.6 ppts 24.4% 21.3% 3.2 ppts OP margin 11.1% 11.4% -0.3 ppts 14.1% 13.0% 1.2 ppts 16.4% 14.1% 2.3 ppts Net margin 9.3% 9.9% -0.6 ppts 12.0% 11.1% 1 ppts 14.4% 11.7% 2.7 ppts Source: Bloomberg Consensus, Macquarie Research, November 2019

Fig 55 P/L Rmb m 2014 2015 2016 2017 2018 2019E 2020E 2021E

Revenue 8,426 10,696 14,612 22,366 25,932 36,572 43,833 50,431 Gross profit 1,289 1,763 2,680 4,803 4,913 7,033 9,710 12,325 GM% 15% 16% 18% 21% 19% 19% 22% 24%

SG&A (320) (352) (485) (594) (644) (936) (1,121) (1,290) R&D (392) (502) (694) (1,168) (1,362) (2,023) (2,423) (2,787) Operating profit 577 909 1,501 3,041 2,907 4,074 6,166 8,248 OPM% 7% 9% 10% 14% 11% 11% 14% 16%

Net interest 36 23 30 32 16 (39) (100) 105 Net investment income 1 (2) (12) (16) (24) (2) - - Forex (16) (37) (37) 43 (377) (180) (100) (100) Other income (expense) 36 (32) (34) 219 329 50 - - Profit before tax 634 862 1,446 3,318 2,851 3,903 5,966 8,254 PBT margin 8% 8% 10% 15% 11% 11% 14% 16%

Income tax (73) (99) (175) (404) (339) (497) (712) (1,010) Minority 5 (2) (1) (13) (22) (3) (3) (3) Net income 566 762 1,271 2,902 2,491 3,403 5,252 7,241 Net margin 7% 7% 9% 13% 10% 9% 12% 14% EPS (Rmb) 0.52 0.70 1.17 2.66 2.27 3.10 4.79 6.60 Source: Company data, Macquarie Research, November 2019

5 November 2019 68 Macquarie Research Global smartphones

Fig 56 Balance sheet Rmb m 2014 2015 2016 2017 2018 2019E 2020E 2021E

Cash & equivalents 505 187 467 1,227 2,254 1,170 2,904 6,339 Receivables 2,388 3,003 3,716 5,666 6,231 9,419 11,073 12,577 Inventory 896 897 2,828 2,622 3,074 4,647 5,421 6,007 Other current assets 391 1,729 2,046 1,961 4,974 4,817 5,310 6,133 Total current assets 4,204 6,017 9,318 11,635 16,768 20,086 24,746 31,306 Fixed assets 1,035 1,141 1,794 2,586 4,523 7,740 9,802 10,939 LT investments 63 126 115 179 150 114 114 114 Other non-current assets 292 352 410 1,326 1,411 1,444 1,390 1,340 Total non-current assets 1,389 1,619 2,319 4,091 6,084 9,299 11,307 12,393 Total assets 5,594 7,636 11,637 15,726 22,852 29,384 36,052 43,700

Short term debt 522 683 904 1,348 1,482 1,327 1,565 1,768 Payables 1,744 2,914 5,573 6,183 7,064 10,134 11,759 13,013 Other current liabilities 31 142 181 175 131 246 271 317 Total current liabilities 2,297 3,739 6,658 7,705 8,677 11,707 13,595 15,098 Long term debt 0 0 0 0 4,080 4,091 4,091 4,091 Other liabilities 46 52 65 502 807 1,458 1,838 2,055 Total LT liabilities 46 52 65 502 4,887 5,549 5,929 6,146 Total liabilities 2,343 3,791 6,723 8,207 13,564 17,257 19,524 21,244

Common stocks 3,248 3,831 4,895 7,489 9,234 11,964 16,364 22,292 Minority equity 3 14 18 31 54 164 164 164 Total equity 3,251 3,845 4,913 7,519 9,288 12,128 16,528 22,456 Total liabilities and equity 5,594 7,636 11,637 15,726 22,852 29,384 36,052 43,700 Source: Company data, Macquarie Research, November 2019

Fig 57 Cash flow statement Rmb m 2014 2015 2016 2017 2018 2019E 2020E 2021E

Profit before tax 634 862 1,446 3,318 2,851 3,903 5,966 8,254 Depreciation 215 246 317 489 771 1,182 1,938 2,363 Amortization 0 0 0 44 44 57 54 51 Change in net working capital -956 520 -180 -1,166 -288 -1,690 -803 -836 Others -76 73 33 -248 190 -600 -1,208 -1,836 Total operating cash flow -183 1,701 1,616 2,436 3,568 2,851 5,947 7,995

Capex -274 -283 -792 -1,142 -2,134 -4,000 -4,000 -3,500 Acquisition -350 -44 -8 -27 0 0 0 0 (Purchase) Sale of ST investment 89 -177 -59 100 -74 201 -3 -213 (Purchase) Sale of LT investment -62 -64 11 -64 28 36 0 0 Others 766 -1,365 -413 -553 -3,319 376 0 0 Total investment cash flow 169 -1,932 -1,260 -1,686 -5,499 -3,387 -4,003 -3,713

Increase (decrease) in debt 33 162 221 444 88 -144 237 203 Cash dividends -133 -170 -228 -318 -725 -623 -851 -1,314 Change in share capital 0 0 0 0 -0 0 0 0 Others -90 -80 -74 -113 3,594 218 405 262 Total financing cash flow -190 -88 -81 12 2,957 -549 -209 -848

Net cash flow -204 -318 274 762 1,025 -1,085 1,735 3,435 FX change -1 1 6 -2 2 1 0 0 Net cash flow after FX change -204 -318 280 760 1,027 -1,084 1,735 3,435

FCF (OCF - Capex) -457 1,419 824 1,294 1,434 -1,149 1,947 4,495 Source: Company data, Macquarie Research, November 2019

5 November 2019 69 Macquarie Research Global smartphones

Macquarie Quant Alpha Model Views The Quant View page below has been derived from models that are developed and maintained by Sales and Trading personnel at Macquarie. The models are not a product of the Macquarie Research Department.

The quant model currently holds a reasonably negative view on Sunny Attractive Displays where the Optical. The strongest style exposure is Profitability, indicating this stock is company’s ranked based on efficiently converting investments to earnings; proxied by ratios like ROE or s

l the fundamental consensus a

ROA. The weakest style exposure is Valuations, indicating this stock is over- t

n Price Target and priced in the market relative to its peers. e

Macquarie’s Quantitative m a Alpha model.

743/949 d n

u Two rankings: Local market Global rank in F (Hong Kong) and Global Technology Hardware & Equipment sector (Technology Quant % of BUY recommendations 80% (33/41) Hardware & Equipment) Local market rank Global sector rank Number of Price Target downgrades 0 Number of Price Target upgrades 37

Macquarie Alpha Model ranking Factors driving the Alpha Model A list of comparable companies and their Macquarie Alpha model score For the comparable firms this chart shows the key underlying styles and their (higher is better). contribution to the current overall Alpha score.

Lenovo Group 0.9 Lenovo Group

China Railway Signal & Co… 0.3 China Railway Signal & Co…

Legend Holdings 0.2 Legend Holdings

Kingboard Chemical Holdin… -0.3 Kingboard Chemical Holdin…

Sunny Optical -0.7 Sunny Optical

AAC Technologies -1.6 AAC Technologies

Meitu -2.4 Meitu

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Valuations Growth Profitability Earnings Price Quality Momentum Momentum

Macquarie Earnings Sentiment Indicator Drivers of Stock Return The Macquarie Sentiment Indicator is an enhanced earnings revisions Breakdown of 1 year total return (local currency) into returns from dividends, changes signal that favours analysts who have more timely and higher conviction in forward earnings estimates and the resulting change in earnings multiple. revisions. Current score shown below.

Lenovo Group Lenovo Group 0.6 China Railway Signal & Co… China Railway Signal & Co… -1.0 Legend Holdings Legend Holdings -0.9 Kingboard Chemical Holdin… Kingboard Chemical Holdin… -0.9 Sunny Optical Sunny Optical 0.2

AAC Technologies -0.8 AAC Technologies

Meitu -0.1 Meitu

-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 -100% -50% 0% 50% 100% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return

What drove this Company in the last 5 years How it looks on the Alpha model Which factor score has had the greatest correlation with the company’s A more granular view of the underlying style scores that drive the alpha (higher is returns over the last 5 years. better) and the percentile rank relative to the sector and market. ⇐ Negatives Positives ⇒ Normalized Percentile relative Percentile relative Price to Cash LTM 27% Score to sector(/949) to market(/560) Alpha Model Score -0.66 Price to Sales LTM 23% Valuation -0.68 Operating Leverage Inc. 23% Growth -0.12 Operating Leverage NTM 20% Profitability 0.30 Earnings Momentum -0.26 Non-current Assets Inc. -18% Price Momentum -0.40 Operating Accruals -19% Quality -0.05 Capital & Funding -0.18 DPS Growth 5yr Historic -22% Liquidity -0.83 EPS Growth 5yr Historic -24% Risk -0.62 Technicals & Trading -0.15 -30% -20% -10% 0% 10% 20% 30% 0 50 100 0 50 100 0 0 1 1

Source (all charts): FactSet, Thomson Reuters, and Macquarie Quant. For more details on the Macquarie Alpha model or for more customised analysis and screens, please contact the Macquarie Global Quantitative/Custom Products Group ([email protected])

5 November 2019 70 Macquarie Research Global smartphones

Sunny Optical (2382 HK) Interim Results 1H/19A 2H/19E 1H/20E 2H/20E Profit & Loss 2018A 2019E 2020E 2021E

Revenue m 15,575 20,998 19,128 24,705 Revenue m 25,932 36,572 43,833 50,431 Gross Profit m 2,864 4,169 4,330 5,380 Gross Profit m 4,913 7,033 9,710 12,325 Cost of Goods Sold m 12,711 16,828 14,798 19,325 Cost of Goods Sold m 21,019 29,539 34,123 38,107 EBITDA m 2,207 3,105 3,771 4,387 EBITDA m 3,720 5,312 8,158 10,662 Depreciation m 529 653 905 1,033 Depreciation m 771 1,182 1,938 2,363 Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0 Other Amortisation m 29 28 27 26 Other Amortisation m 41 57 54 51 EBIT m 1,649 2,424 2,839 3,327 EBIT m 2,907 4,074 6,166 8,248 Net Interest Income m -7 -32 -62 -38 Net Interest Income m 16 -39 -100 105 Associates m -2 0 0 0 Associates m -24 -2 0 0 Exceptionals m 0 0 0 0 Exceptionals m 0 0 0 0 Forex Gains / Losses m -30 -150 -50 -50 Forex Gains / Losses m -377 -180 -100 -100 Other Pre-Tax Income m 50 -0 -0 0 Other Pre-Tax Income m 329 50 -0 0 Pre-Tax Profit m 1,661 2,242 2,727 3,239 Pre-Tax Profit m 2,851 3,903 5,966 8,254 Tax Expense m -228 -269 -338 -374 Tax Expense m -339 -497 -712 -1,010 Net Profit m 1,432 1,973 2,389 2,865 Net Profit m 2,513 3,406 5,254 7,243 Minority Interests m -1 -1 -1 -1 Minority Interests m -22 -3 -3 -3

Reported Earnings m 1,431 1,972 2,388 2,864 Reported Earnings m 2,491 3,403 5,252 7,241 Adjusted Earnings m 1,431 1,972 2,388 2,864 Adjusted Earnings m 2,491 3,403 5,252 7,241

EPS (rep) 1.31 1.80 2.18 2.61 EPS (rep) 2.27 3.10 4.79 6.60 EPS (adj) 1.31 1.80 2.18 2.61 EPS (adj) 2.27 3.10 4.79 6.60 EPS Growth yoy (adj) % 21.4 50.4 66.6 45.2 EPS Growth (adj) % -14.7 36.7 54.2 37.9 PE (rep) x 50.1 36.7 23.8 17.2 PE (adj) x 50.1 36.7 23.8 17.2

EBITDA Margin % 14.2 14.8 19.7 17.8 Total DPS 0.57 0.78 1.20 1.65 EBIT Margin % 10.6 11.5 14.8 13.5 Total Div Yield % 0.5 0.7 1.1 1.5 Earnings Split % 42.1 57.9 45.5 54.5 Basic Shares Outstanding m 1,092 1,092 1,092 1,092 Revenue Growth % 30.0 50.5 22.8 17.7 Diluted Shares Outstanding m 1,097 1,096 1,097 1,097 EBIT Growth % 10.2 71.8 72.1 37.2

Profit and Loss Ratios 2018A 2019E 2020E 2021E Cashflow Analysis 2018A 2019E 2020E 2021E

Revenue Growth % 15.9 41.0 19.9 15.1 EBITDA m 3,720 5,312 8,158 10,662 EBITDA Growth % 4.1 42.8 53.6 30.7 Tax Paid m -339 -497 -712 -1,010 EBIT Growth % -4.4 40.1 51.4 33.8 Chgs in Working Cap m -137 -1,690 -803 -836 Gross Profit Margin % 18.9 19.2 22.2 24.4 Net Interest Paid m 16 -39 -100 105 EBITDA Margin % 14.3 14.5 18.6 21.1 Other m 307 -235 -596 -926 EBIT Margin % 11.2 11.1 14.1 16.4 Operating Cashflow m 3,568 2,851 5,947 7,995 Net Profit Margin % 9.6 9.3 12.0 14.4 Acquisitions m 0 0 0 0 Payout Ratio % 25.0 25.0 25.0 25.0 Capex m -2,134 -4,000 -4,000 -3,500 EV/EBITDA x 34.6 24.1 15.7 12.0 Asset Sales m 0 0 0 0 EV/EBIT x 44.4 31.4 20.7 15.5 Other m -3,365 613 -3 -213 Investing Cashflow m -5,499 -3,387 -4,003 -3,713 Balance Sheet Ratios Dividend (Ordinary) m -725 -623 -851 -1,314 ROE % 29.8 32.1 37.1 37.5 Equity Raised m 0 0 0 0 ROA % 15.1 15.6 18.8 20.7 Debt Movements m 4,215 -144 237 203 ROIC % 33.5 28.2 33.2 37.5 Other m -533 218 405 262 Net Debt/Equity % 35.6 35.0 16.6 -2.1 Financing Cashflow m 2,957 -549 -209 -848 Interest Cover x nmf 105.2 61.9 nmf Price/Book x 13.5 10.4 7.6 5.6 Net Chg in Cash/Debt m 1,027 -1,084 1,735 3,435 Book Value per Share 8.5 11.0 15.0 20.4 Free Cashflow m 1,434 -1,149 1,947 4,495

Balance Sheet 2018A 2019E 2020E 2021E

Cash m 2,254 1,170 2,904 6,339 Receivables m 6,231 9,419 11,073 12,577 Inventories m 3,074 4,647 5,421 6,007 Investments m 284 81 85 297 Fixed Assets m 4,523 7,740 9,802 10,939 Intangibles m 349 450 396 346 Other Assets m 6,136 5,877 6,371 7,194 Total Assets m 22,852 29,384 36,052 43,700 Payables m 7,064 10,134 11,759 13,013 Short Term Debt m 1,482 1,327 1,565 1,768 Long Term Debt m 4,080 4,091 4,091 4,091 Provisions m 0 0 0 0 Other Liabilities m 938 1,704 2,109 2,372 Total Liabilities m 13,564 17,257 19,524 21,244 Shareholders' Funds m 9,234 11,964 16,364 22,292 Minority Interests m 54 164 164 164 Other m 0 0 0 0 Total S/H Equity m 9,288 12,128 16,528 22,456 Total Liab & S/H Funds m 22,852 29,384 36,052 43,700

All figures in Rmb unless noted. Source: Company data, Macquarie Research, November 2019

5 November 2019 71

5 November 2019 Hong Kong

EQUITIES Q Technology Group (1478 HK)

Robust revenue growth in the coming years Serious contender in camera modules

(Rmbm) 30,000 140% 25,000 120% Key points 100% 20,000 80% 15,000  We initiate coverage with an Outperform rating and a target price of 60% 10,000 HK$12.90 based on 20x 2020E EPS, implying 23% upside potential. 40% 5,000 20%  Camera module technology improvement will enable Q Tech to increase - 0% market share in Huawei and Oppo’s flagship smartphones from 2019.  Increasing market demand for multi-camera with spec upgrades to drive Q Revenue YoY (RHS) Tech’s net income to have a CAGR of 39% over 2020-21E.

Source: Company data, Macquarie Research, Nov 2019 1478 HK Outperform Price (at 14:33, 01 Nov 2019 GMT) HK$10.52 Share gain by technology improvement

Valuation HK$ 12.90 To compete with the established players in camera modules, Q Tech deploys two - PER key strategies: 1) R&D investment and technology upgrade and 2) selective 12-month target HK$ 12.90 customer targeting. The company’s camera module miniaturisation packaging Upside/Downside % +22.6 technology are in production and continues to develop high resolution (64MP, 12-month TSR % +23.8 108MP) modules with new assembly technology. The company entered the Volatility Index Very High Huawei camera module supply chain in early 2018 and has progressively gained GICS sector Consumer Durables & Apparel market share as a second or third supplier in high-end and flagship smartphones Market cap HK$m 11,927 since 2019. Market cap US$m 1,522 Multiple years of multi-camera upgrades Free float % 33 30-day avg turnover US$m 9.5 We forecast the number of camera/lenses in the market will increase from our Number shares on issue m 1,134 estimate of 3.6bn units in 2018 to 4.1bn/4.8bn/5.6bn in 2019/20/21E, and the

Investment fundamentals number of cameras per smartphone to increase to 2.9/3.3/3.8 units. Our survey of new smartphones launched by the top six brands in 2019 suggests that camera Year end 31 Dec 2018A 2019E 2020E 2021E Revenue m 8,135 13,073 20,257 26,159 specs migration is accelerating, with 48MP, 64MP and even 108MP main camera EBIT m 16 522 806 1,023 adoptions in 2H19, and increasing penetration of ultrawide angle and optical EBIT growth % -96.8 3,081.8 54.2 27.0 zoom cameras. We expect Q Tech’s camera module volumes and ASP to show a Reported profit m 14 426 635 823 three-year CAGR of 27% and 19% over 2019-21E, respectively. Adjusted profit m 14 426 635 823 EPS rep Rmb 0.01 0.37 0.56 0.72 EPS rep growth % -96.7 2,812.7 49.2 29.6 Fingerprint technology migration EPS adj Rmb 0.01 0.37 0.56 0.72 The first fingerprint tech cycle was in 2015 to 2017 with cover and coating EPS adj growth % -96.8 2,848.0 49.1 29.6 PER rep x 738.1 25.3 17.0 13.1 capacitive sensor; in 2018, the market started transitioning to the under-display PER adj x 747.0 25.3 17.0 13.1 technology to maximise display-to-body ratio. We expect the overall market to Total DPS Rmb 0.00 0.07 0.11 0.14 continue to migrate from capacitive to under-display form factor, while the high- Total div yield % 0.0 0.8 1.2 1.5 end segment will upgrade to the new thin form factor in 4Q19, which further ROA % 0.3 6.8 8.0 8.3 ROE % 0.7 18.2 22.3 23.7 supports ASP improvement and steady gross margin. EV/EBITDA x 51.5 14.0 9.9 8.2 Net debt/equity % 51.3 60.8 50.7 36.9 Initiate coverage with an Outperform rating P/BV x 5.0 4.2 3.5 2.8 We initiate coverage of Q Tech with an Outperform rating and a target price of Source: FactSet, Macquarie Research, November 2019 (all figures in Rmb unless noted, TP in HKD) HK$12.90, based on 20x FY20E EPS. We expect the company’s continuous Macquarie Governance and Risk Score (MGRS) technology improvement and share gain in high-end projects to drive an average On our proprietary Governance and Risk Score Q Technology Group scores in the second quartile of our 39% annual net income growth over 2020-21E. current universe coverage. Near-term catalyst: ASP increase in 2H19 on better product mix. Analysts

Macquarie Capital Limited Fundamental catalyst: Clear trend of multi-cameras and under-display

Cherry Ma +852 3922 5800 fingerprint adoptions in smartphones. [email protected] Risks: downside to Huawei’s smartphone outlook could hinder Q Tech’s growth Nicolas Baratte +852 3922 5801 [email protected] trajectory.

5 November 2019 72 Macquarie Research Global smartphones

Inside Q Technology

Company profile Serious contender in camera modules 74 Founded in 2007 and headquartered in Kunshan, China, Q Technology is a top- Good strategy and execution 75 four domestic camera module maker and a top-two fingerprint module maker in Market opportunities 81 China, serving the mid- to high-end segments. The company has its main Initiate with Outperform 84 manufacturing base in China and has expanded camera module production to India in 2019. The majority of the company’s revenue is derived from top Chinese Android OEMs and domestic smartphone ODMs, but it also has some exposure Q Tech’s top 5 customer exposure (1H19) to electronic brands for outdoor sports cameras and domestic vehicle brands. Q Tech’s product capabilities include high-resolution single cameras, multi- Others cameras, 3D cameras, vehicle camera module and capacitive and under-display 10% fingerprint modules. Riding the multi-camera and under-display fingerprint sensor trends, we expect Q Tech’s revenue to show a CAGR of 48% over 2019-20-21E.

Top 5 customers (Vivo, Huawei, Oppo, Fig 1 Q Tech’s revenue growth Xiaomi, Huaqin) 90% (Rmbm) 30,000 140%

25,000 120% Source: Company data, November 2019 100% 20,000 80% ROE and ROIC 15,000 60% 30% 10,000 40% 25% 5,000 20% 20% - 0% 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 15%

10% Revenue YoY (RHS)

5% Source: Company data, Macquarie Research, November 2019

0% 2014 2015 2016 2017 2018 2019E 2020E 2021E

ROE ROIC Fig 2 1478 HK rel HSI performance, & rec history Source: Company data, Macquarie Research, November 2019

PE chart

(x) 50 45 40 35 30 25 20 15 10 5 0

Jan15 Jan16 Jan17 Jan18 Jan19

Sep15 Sep16 Sep17 Sep18 Sep19

May15 May16 May17 May18 May19 Note: Recommendation timeline - if not a continuous line, then there was no Macquarie PE 5x 12x coverage at the time or there was an embargo period. 20x 27x 34x Source: FactSet, Macquarie Research, November 2019 Source: Bloomberg, Macquarie Research, November 2019 (all figures in Rmb unless noted, TP in HKD)

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Macquarie Research Global smartphones

Serious contender in camera modules

Investment summary

Gaining share in camera module business, hot on O-film’s heels • Q Tech has been growing its camera module revenue at a 5-year CAGR of 35% over 2014-18. Strong camera module revenue growth • Company focuses on product development and technology upgrade to gain market share. R&D (Rmbm) 25,000 18% spending has shown a five-year CAGR of 39% over 2013 to 2018. 16% 20,000 14% 12% • Q Tech has prudent capacity plans and progressively built up relationships with customers over 15,000 10% 10,000 8% 6% the past 6-7 years: Vivo in 2012, Oppo in 2014, Xiaomi in 2016 and Huawei in 2018. 5,000 4% 2%

- 0% • In 2019, Q Tech’s share gain in Huawei’s flagship models (P and Mate series) demonstrates the

2014 2012 2013 2015 2016 2017 2018

2011 company’s capabilities in producing premium camera modules. Q Tech expects to increase

2019E 2020E 2021E Camera module GM% (RHS) market share in Huawei’s camera module supply chain going forward, hot on O-Film’s heels.

Source: Company data, Macquarie Research, November 2019 Diversifying into fingerprint module business • In 2015, Q Tech diversified into fingerprint module assembly at the beginning of the Android adoption wave. However, the first fingerprint product cycle (2015-17) had limited upgrades. The relatively low entry barrier also attracted new entrants, resulting in ASP and margin squeeze.

Fingerprint module revenue • The second product cycle wave came in 2018, with capacitive module upgrading to under- and gross margin recovery display optical modules; the latter requires chip-on-board production line (shared with camera

(Rmbm) module production) which increased the entry barrier and eliminated smaller players. 5,000 12% 4,500 4,000 10% 3,500 8% Going upstream with a stake in Newmax 3,000 2,500 6% 2,000 1,500 4% • Beyond a module maker, Q Tech diversifies upstream and owns a 35.3% stake in Newmax, an 1,000 2% 500 optical lens maker in Taiwan. Newmax is a specialist in lenses for 3D sensing and also - 0% produces lenses for optical fingerprint modules. Q Tech is cooperating with Newmax to include their RGB lenses in Q Tech’s own camera module solutions for client adoption. Fingerprint modules GM% (RHS) Source: Company data, Macquarie Riding on smartphone market recovery on 5G and Multi-year camera upgrade Research, November 2019 • We believe 5G smartphones will create a wave of replacement demand in the coming five years. The first wave of 5G smartphones was launched in 2019 by several Android brands in selected markets. In 2020, brands will be launching mid-range 5G smartphones. We forecast global smartphone volumes to decline by 1.7% in 2019 and recover and grow by +0.5%, +2.6% and +4.0% to 1.53bn, 1.57bn and 1.64bn units over 2020, 2021 and 2022, respectively.

Increasing smartphone • Besides overall market recovery, we expect Q Tech to grow its camera module business camera industry value through increasing market demand and customer share gain, and to grow its fingerprint module

(US$bn) business by riding on the under-display module upgrade trend. We have tracked 132 60 8% 8% 9% 7% 7% 8% 50 7% 7% smartphones launched by top six Android brands and we observe acceleration in camera specs 40 5% 5% 5% 6% 4% 5% upgrade with increasing number of lenses, higher resolution of the main (up to 108MP) and 30 4% 4% 20 3% secondary camera (up to 16MP) and wider adoption of ultrawide angle and telephoto lenses. 2% 10 1% - 0% • We forecast smartphone camera content upgrade will drive overall industry value to grow from

Industry value - camera our estimate of US$22.8bn in 2018 to US$45bn by 2023E; percentage of total value will % of total smartphone value increase from 5.1% in 2019 to 7.1% by 2023E. Source: Company data, Macquarie Research, November 2019 • Through technological improvement, Q Tech has been making good market share progress within the Huawei and Oppo camera module supply chain, with increasing share in flagship models. We expect segment revenue to show a CAGR of 51% over 2019-21E.

• Moreover, Q Tech is also a fingerprint module supplier to these top brands. We expect to see increasing penetration of under-display modules; within the flagship models, there will be upgrades to new thin-form factor to accommodate bigger battery size. We expect segment ASP to increase by 67% in 2019 and 16% YoY in 2020E, with gross margin improving from 1.9% in 2018 to about 10% in 2019-21E.

Valuation • We initiate coverage on Q Tech with an Outperform rating and a target price of HK$12.90, based on 20x 20E EPS. We expect Q Tech’s continuous technology improvement and share gain in high-end projects to drive an average of 39% annual net income growth over 2020-21E.

5 November 2019 74 Macquarie Research Global smartphones

Good strategy and execution With just over a decade of production experience, Q Tech is a relatively young company in the supply chain, producing mid- to high-end products for leading Android customers. Q Tech currently ranks as the third camera module maker in China in terms of capacity, after O-Film and Sunny Optical. Q Tech is also the second-largest fingerprint module maker in China, ranking after O-Film. Between 2013 and 2018, the company showed a revenue CAGR of 42%.

Fig 3 Q Tech’s total revenue and growth (2011-21E)

(Rmbm) 30,000 140%

25,000 120% 100% 20,000 80% 15,000 60% 10,000 40%

5,000 20%

- 0% 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Revenue YoY (RHS)

Source: Company data, Macquarie Research, November 2019

Key to gain share and scale To compete with the established players in camera modules, the company deploys two key strategies of 1) R&D investment and technology upgrade and 2) selective customer targeting.

R&D investment Q Tech’s R&D spending has shown a five-year CAGR of 39% over 2013 to 2018, slightly below its revenue five-year CAGR of 42%. The company commits on average about 3.0-3.5% of revenue to R&D spending to advance in product design and develop the latest packaging technology to fulfil customers’ demand for miniaturised form factors. Compared to its peers, Sunny’s 5.3% and O- Film’s 4.7%, Q Tech’s R&D ratio is lower as it only has two main product lines, whereas its peers have four or five product groups.

Fig 4 Increasing R&D spending with steady ratio

(m units) 1,000 4.5% 900 4.0% 800 3.5% 700 3.0% 600 2.5% 500 2.0% 400 300 1.5% 200 1.0% 100 0.5% 0 0.0% 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E R&D R&D to revenue ratio

Source: Company data, Macquarie Research, November 2019

5 November 2019 75 Macquarie Research Global smartphones

As of result of Q Tech’s R&D effort, its camera module shipment and product mix had been improving between 2013 and 2017. Total camera module annual shipment had a five-year CAGR of 41% from 2013 to 2018, versus a CAGR of 26% for Sunny Optical. Above 10MP camera mix increased from 1% in 2013 to 36% in 2017; dual camera mix also reached about 12% in 2017. However, in 2018, Q Tech’s product mix deteriorated because of strategic share gain in Huawei (starting from the low end), not because of lack of capabilities. As of 1H19, the company had commenced mass production of 48MP camera modules and has ongoing R&D efforts in 64MP and 108MP high-resolution cameras, ultra-wide angle cameras and periscope form factor to achieve high optical zoom.

Fig 5 Q Tech’s camera module shipment vs Sunny Fig 6 Q Tech’s product mix

(m units) 800 100% 1% 1% 3% 5% 6% 7% 10% 12% 11% 11% 700 90% 22% 80% 23% 600 70% 36% 32% 37% 40% 500 60% 400 50% 38% 40% 24% 300 30% 200 20% 100 10% 0 0% 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Q Tech Sunny Below 5MP 5MP 8MP 10-20MP Above 20MP Dual cameras

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Selective customer share gain strategy When Q Tech first started its business, it focused on cultivating a few customers per year due to its limited resources and capacity. In 2012, Q Tech gained qualification with Vivo and subsequently with Oppo in 2013. Since then, Vivo and Oppo have become Q Tech’s core customers for high- end camera modules. In 2017, Q Tech finally qualified as a Huawei camera module supplier and started shipping in 2018. However, Huawei’s supply chain was hard to break into, and a new supplier needed to start from low-end products and prove its quality and consistency before getting into the mid- to high-end product range. Therefore, in 2018, Q Tech’s product mix, ASP and gross margin deteriorated YoY, as a strategic decision to gain market share in the Huawei supply chain. In terms of pricing strategy, Q Tech competes based solely on price, only if the projects are strategically advantageous for portfolio build-out or future share gain. In 2019, Q Tech gained market share in Huawei’s 48MP camera projects but not in periscope-style cameras; we would expect the company to be aggressive on pricing to gain qualification of premium products.

Fig 7 Q Tech’s milestones 2007- 2008 2009 2011 2012 2014 2015 2016 2017 2018 2019

Customer Company ZTE Lenovo TCL Asus Fingerprint: Xiaomi Huawei Huawei's low- Huawei's mid qualification establishment Coolpad Vivo Oppo Huawei, Xiaomi, (camera (camera end projects to high end Oppo and Vivo module) modules) projects Meizu

Technology Commenced 3MP and 8MP and 16MP and Dual camera (shared frame Investment Auto camera 48-64MP readiness mass 5MP camera 13MP 20MP and shared substrate) in Newmax module for a camera production of modules camera camera Fingerprint module (cover Chinese auto modules camera modules modules and coating) OEM modules Under-display fingerprint module 3D structured- light module Source: Company data, Macquarie Research, November 2019

5 November 2019 76 Macquarie Research Global smartphones

In 1H19, Q Tech’s top five customers – Vivo, Huawei, Oppo, Xiaomi and Huaqin – accounted for about 90% of revenue. The concentration of the top five customers, which is not the same every year, has gone up, but we believe the mix within the top five customers became more balanced as the company gained share in Huawei’s camera modules in 2018-19.

Fig 8 1H19 revenue mix by top 5 customers

100%

80%

60% 90% 40% 79% 84%

20%

0% 2017 2018 1H19

Others Top 5 customers (Vivo, Oppo, Xiaomi, Huawei, Lenovo) Top 5 customers (Vivo, Huawei, Oppo, Xiaomi, Yinuo) Top 5 customers (Vivo, Huawei, Oppo, Xiaomi, Huaqin)

Source: Company data, Macquarie Research, November 2019

Capacity and expansion to India Q Tech has been cautious on capacity expansion as it focused on migration from the mid-end to the high-end market, rather than grabbing volume share by filling capacity with low-end projects. In 2019, the company targets to grow its camera module capacity to 50m per month, namely 47m per month of domestic capacity and 3m per month in Uttar Pradesh, India. Besides local tax advantages, being in India allows Q Tech to be close to its customers, Vivo and Oppo. Q Tech is currently test-running the production lines; we expect the company to commence mass production in 1Q20.

Fig 9 Q Tech’s camera module monthly capacity

(m unit per month) 60

50 3 40

30 47 20 35 30 23 10 16 11 0 2014 2015 2016 2017 2018 2019

Camera monthly capacity India

Source: Company data, Macquarie Research, November 2019

5 November 2019 77 Macquarie Research Global smartphones

Diversified into fingerprint modules since 2015 Early adoption of fingerprint sensors in Android smartphones started in 2015. Q Tech was one of the early players to diversify from camera modules to capacitive fingerprint module assembly. Since the assembly equipment and processes for camera modules and fingerprint modules are similar, the entry barriers for existing camera module makers is relatively lower.

Slow tech upgrade cycle at the beginning of adoption However, the tech upgrade cycle for fingerprint modules is much slower than for cameras. Cover and coating form factors were the two main options for capacitive fingerprint modules in the first three years of adoption from 2015 to 2017. As a result of the slow fingerprint tech upgrade cycle, shrinking ASP and margins, some camera module makers, such as Sunny and LuxVision, did not participate in or diversify into fingerprint module assembly business. The biggest player in this field is O-Film, followed by Q Tech. Q Tech’s top 5 customers in this segment are Huawei, Xiaomi, Vivo, Oppo and Huqain, which in aggregate accounted for 99% of the segment revenue in 2018.

Excess capacity of capacitive fingerprint modules Capacity in the market has become abundant due to the slow upgrade cycle since 2017. Q Tech and O-Film’s fingerprint module monthly capacity reached 17m units and 32-33m units in 2017, respectively, and neither company has expanded since then. There are also smaller suppliers of capacitive fingerprint modules in the market, due to the low entry barrier.

Fig 10 Q Tech and O-Film’s fingerprint module monthly capacity

(m units) 35 32 33 33 30 28

20 17 17 17

15 10 10 10

5 3

0 2015 2016 2017 2018 1H19 Q Tech O-Film

Source: Company data, Macquarie Research, November 2019

Under-display modules have higher entry barrier In 2018, flagship Chinese Android smartphone started upgrading to under-display optical fingerprint module or side-mounted capacitive modules to eliminate the front home button/ fingerprint sensor to increase display size and ratio. Entry barrier of the under-display form factor is higher for the smaller players due to the additional investment of chip-on-board assembly process, which O-Film and Q Tech already have in their camera module assembly lines. Therefore, the market supply for under-display modules are more consolidated within the top firms, providing better margin outlook.

5 November 2019 78 Macquarie Research Global smartphones

Fig 11 Fingerprint module shipment and ASP comparison Fig 12 Fingerprint module gross margin comparison

(m units) (Rmb) 250 45 18% 16% 40 200 14% 35 12% 150 10% 30 8% 100 25 6%

50 4% 20 2% - 15 0% 2015 2016 2017 2018 1H19 2015 2016 2017 2018 1H19

Q Tech O-Film Q Tech ASP O-Film ASP Q Tech O-Film

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

O-Film led the product upgrade cycle and transformed part of its capacity to produce the new form factors. ASP of the side-mounted capacitive module and under-display module are 1.5x and 3x higher than the legacy product. The gross margin of under-display modules is in the double digits, compared to the low single digit gross margin of the legacy products, as market share concentration increases with under-display form factor. As a result, O-Film was able to slow down blended ASP decline and only a slight gross margin decline in 2018. However, Q Tech only started shipping under-display module in late 2018; the segment still suffered steep ASP and gross margin decline as legacy modules accounted for about 88% of the shipment mix during the year. In 2019, market adoption of under-display fingerprint sensors continues to increase; Q Tech transformed 8m out of its 17m total monthly capacity to produce the under-display modules. Company also decided to forgo some legacy projects to improve overall profits. In 1H19, fingerprint modules shipment volume declined by -16% YoY; however, with mix improvement, ASP doubled YoY, revenue increased by 81% YoY and gross margin improved by 700bps YoY. From January to September, Q Tech’s under-display module accounted for 53% of the shipment mix.

Fig 13 Fingerprint module shipment mix Fig 14 Fingerprint module revenue vs shipment

(Rmbm) (m units) 100% 1,400 70 90% 80% 37% 1,200 60 42% 46% 41% 45% 53% 52% 51% 70% 60% 1,000 50 60% 50% 800 40 40% 30% 63% 600 30 58% 54% 59% 55% 47% 48% 49% 20% 40% 400 20 10%

0% 200 10

Jul-19

Apr-19 Jan-19

Jun-19 - -

Feb-19 Mar-19

Aug-19 Sep-19 May-19 1H18 2H18 1H19

% Under-glass % Non-under-glass Fingerprint revenue Shipment (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 79 Macquarie Research Global smartphones

Going upstream with investment in Newmax Besides traditional lens makers like Largan and Sunny Optical, other component makers in the smartphone industry are also eyeing the high profit profile of handset lens sets, and have started investing by various means.

• AAC Technology, a leader in smartphone acoustics, began smartphone plastic lens set production in 2017, and currently offers low- to mid-range standardised lenses to camera module makers in China.

• O-Film entered smartphone plastic lens set production in 2018 and supplies lenses internally to its camera module division. Q Tech invests in optical lens sets through its share subscription in Newmax (3630 TT – not rated), a 3D sensing lens marker. In 2017, Q Tech entered into a share subscription agreement with Newmax to acquire a 36% interest for a consideration of approximately Rmb275m. In 1H19, Q Tech further increased its investment in Newmax by participating in Newmax’s proposed capital injection, at a price of NT$82.8 per share for about 8.32m shares (total consideration of about Rmb158m). Post Newmax’s capital injection, Q Tech’s ownership was slightly diluted to 35.3%.

Increasing synergy with Newmax Founded in 1999 and headquartered in Taiwan, Newmax’s current product mix specialises in optical lens sets for 3D sensing applications in gaming, PC, smartphones, and provides lenses to optical fingerprint modules. Q Tech is assisting Newmax to improve quality and gain RGB smartphone camera lenses in the Chinese Android supply chain. Newmax’s sales from 2Q18 to 4Q18 rebounded by +135% YoY. Sales in 1H19 further increased by 237% YoY, as Newmax’s lenses were qualified to supply to Q Tech’s 3D sensing modules, standard RGB camera and under-display optical modules. Going forward, with the capital raised, Newmax will be expanding its capacity in Taichung, while Q Tech would promote Newmax’s RGB lenses in its Apollo Project, a camera module total solution, to its smartphone customers. We expect Q Tech’s associate income to reach Rmb51m in 2019.

5 November 2019 80 Macquarie Research Global smartphones

Market opportunities

Smartphone recovery with 5G replacement cycle We believe 5G smartphones would create a wave of replacement demands in the coming five years. In 2019, the first wave of 5G smartphones were launched by multiple Android brands in selected markets. In 2020, brands will be launching mid-range 5G smartphones. We forecast global smartphone volumes to decline by -1.7% in 2019 and recover and grow by +0.5%, +2.6% and +4.0% to 1.53bn, 1.57bn and 1.64bn units over 2020-21-22E.

Camera modules Besides overall market recovery, we expect Q Tech to grow its camera module business through market demand increase and customer share gain.

Market demand increasing We’ve tracked 132 new smartphones launched by top six Android brands and we observe acceleration in camera specs upgrade with increasing number of lenses, higher resolution of the main camera (up to 108MP) and secondary camera (up to 16MP) and wider adoption of ultrawide angle and telephoto zoom.

Fig 15 Camera resolution of new smartphone lenses (sample of 132 smartphones)

(lens set) 100 supporting lens with special Front or back main/ secondary 90 features cameras 80 70 60 50 40 30 20 10 0 Camera resolution of new smartphones (2019 YTD)

TOF 2MP 5MP 8MP 10MP 12MP 13MP 16MP 20MP 24MP 25MP 32MP 40MP 48MP 64MP 108MP

Source: Company data, Macquarie Research, November 2019

We observe 48MP and 64MP resolution are the main spec for flagship models this year and expect increasing penetration to mid-to-high end smartphones in 2020. Flagship models are likely to upgrade to 64MP and 108MP resolution for the main cameras in 2020. Higher pixel cameras often come with larger sensor and lenses. The bigger and heavier lenses set require Shape Memory Alloy (SMA) actuator, instead of traditional VCM, to adjust the lens for autofocus. Assembly process of camera modules with SMA actuator require new steps; Q Tech is developing its assembly capability for higher resolution and new actuator upgrade. We expect triple and quad camera penetration in total smartphones to increase, reaching 41% in 2020 and 61% in 2021, and the number of cameras per smartphone to reach 3.3 units and 3.8 units in the same period.

5 November 2019 81 Macquarie Research Global smartphones

Fig 16 Number of camera lenses per smartphone Fig 17 Penetration of multi-camera in smartphones

(m units) (units per 3.8 6,000 phone) 4.0 100% 3.3 3.5 90% 5,000 2.9 80% 3.0 70% 4,000 2.4 2.1 2.2 2.5 60% 3,000 2.0 50% 45% 40% 1.5 34% 2,000 30% 1.0 20% 18% 1,000 16% 10% 0.5 6% 0% 1% 1% 0 - 2016 2017 2018 2019E 2020E 2021E 2016 2017 2018 2019E 2020E 2021E Single Dual Triple Total lens demand Camera per phone Quad Other

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

We estimate the industry value for smartphone camera to increase from our estimate of US$23.5bn in 2019 to US$45bn by 2023. Our calculation is based on our blended iPhone camera content estimate of US$40 and Android camera content estimate of US$12 in 2019, which would grow by a five-year CAGR of about 14% to average camera content of US$76 for the iPhone and US$20 for an Android smartphone on the increasing multi-cam adoption per phone.

Fig 18 Increasing Industry value for camera

(US$bn) 60 9.0% 48.6 8.0% 50 45.4 41.4 7.0% 40 37.1 6.0% 33.1 5.0% 30 23.5 21.3 22.8 4.0% 20 15.5 3.0% 12.9 2.0% 10 1.0% - 0.0% 2015 2016 2017 2018 2019E 2020E 2021E 2022E 2023E 2024E

Industry value - camera % of total smartphone value

Source: Macquarie Research, Gartner, November 2019

Customer share gain in Huawei and Oppo Through technology improvement, Q Tech has been making good market share progress within the Huawei and Oppo supply chain. In 2018, Q Tech mainly produced 2MP standardised camera modules for Huawei, and in 2019, Q Tech started producing front and back camera modules (non- periscope) for flagship models as a second to third source supplier. For Oppo, Q Tech has been a supplier to its flagship models in the past and is seeing increasing market share in flagship projects as a first to second source supplier. We believe Q Tech’s share gain with these two customers are not due to the technology short fall of existing suppliers, but supply chain diversification strategy of the brands in preparation or the increasing demand for higher specs cameras in the coming years.

5 November 2019 82 Macquarie Research Global smartphones

Fig 19 Huawei’s multi-cam penetration by price segment Fig 20 Oppo’s multi-cam penetration by price segment

100% 100% 8% 90% 14% 90% 33% 33% 80% 80% 40% 50% 70% 70% 67% 71% 60% 58% 60% 50% 50% 86% 40% 40% 40% 67% 67% 30% 30% 50% 20% 25% 20% 33% 29% 10% 10% 20% 8% 0% 0% Low-end Mid-range High-end Premium Low-end Mid-range High-end Premium

Single Dual Triple Quad Single Dual Triple Quad

Source: Company data, Macquarie Research, November 2019 Source:

Fingerprint tech upgrade continues While the first wave of meaningful tech upgrade in fingerprint module from capacitive to under- display took three years (2015 to 2018), we expect the next upgrade is just around the corner. New smartphone designs are looking to increase the battery size for prolonged battery life, therefore, requiring slimmer form factor for fingerprint module. The height of the under-display module to reduce from 3-3.5mm to 0.3-0.4mm. We expect to see new thin under-display form factors launched in smartphones in 4Q19, in which the component ASP could increase by double digit of its predecessor. We expect Q Tech to reduce capacitive fingerprint volumes in favour of increasing demand of under-display modules.

5 November 2019 83 Macquarie Research Global smartphones

Initiate with Outperform

Robust revenue growth We expect the overall revenue to show a three-year CAGR of 48% to Rmb13.0bn, Rmb20.3bn and Rmb26.2bn over 2019, 2020 and 2021E, respectively.

• Camera module product mix started improving in 3Q19, as proportion of >10MP cameras rose to 58% compared with 47% in 1H19. We forecast camera module ASP will increase from Rmb21.5 in 1H19 to Rmb31.4 in 2H19 on share gain in >10MP cameras. With the increasing resolution and penetration of multi-cam, we expect Q Tech to deliver camera module volume growth of 47%, 19% and 17% over 2019, 2020 and 2021E, respectively, while segment revenue to show a CAGR of 51% over the same period on ASP and volume growth.

Fig 21 Q Tech’s camera module revenue and gross margin Fig 22 Q Tech’s camera module shipment and ASP

(Rmbm) (m units) (Rmb) 25,000 18% 600 45 16% 40 500 20,000 14% 35 12% 400 30 15,000 10% 25 300 8% 20 10,000 6% 200 15 4% 10 5,000 100 2% 5 - 0% 0 0

Camera module GM% (RHS) Camera module ASP (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

• Fingerprint module product mix has improved significantly in 2019 from 12% under-display mix in 2018 to 53% in 9M19. We estimate under-display module mix will reach 50% in 2019 and increase to 68% in 2020E and 69% in 2021E. We forecast segment revenue will show a three- year CAGR of 34% over 2019-21E on moderate shipment growth and under-display modules mix improvement driving moderate ASP increase.

Fig 23 Q Tech’s fingerprint revenue and gross margin Fig 24 Q Tech’s fingerprint module shipment and ASP

(Rmbm) (m units) (Rmb) 5,000 12% 160 40 4,500 140 35 4,000 10% 120 30 3,500 8% 3,000 100 25 2,500 6% 80 20 2,000 1,500 4% 60 15 1,000 2% 40 10 500 20 5 - 0% 2016 2017 2018 2019E 2020E 2021E - 0 2016 2017 2018 2019E 2020E 2021E

Fingerprint modules GM% (RHS) Fingerprint modules ASP (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 84 Macquarie Research Global smartphones

Steady gross margin We expect gross margin to remain steady at 8.1%/8.2%/8.0% in 2019/20/21E.

• Q Tech’s camera module gross margin dropped significantly in 1H18 to 3.3% due to the increased mix of 2MP modules to Huawei and sharp RMB depreciation. In 2019, we forecast segment gross margin in 2H19 to slightly contrast from 7.6% in 1H19 to 7.4% as the company expects to earn less percentage premium on product mix above 24MP due to higher sensor price. We model for gross margin to reach 7.5% in 2020E and 7.6% in 2021E.

• Fingerprint gross margin in 1H19 increased by about 320bps HoH to 10.1% on increasing volumes of under-display modules and declining volumes of capacitive modules. In 2H19, we expect gross margin to contrast by about 20bps HoH on the increasing volume mix of capacitive modules. Going forward, we forecast the mix of under-display module will increase from 50% in 2019 to 68% in 2020 and 69% in 2021, and gross margin to reach 9.9%, 10.7% and 10.1% in 2019, 2020 and 2021E, respectively.

Operating income Company recorded an operating loss in 2018 due to 1) the Huawei share gain strategy causing gross margin erosion and 2) steep ASP and profit decline of the capacitive fingerprint module business. In 1H19, company’s operating profit already recorded a turnaround on product mix improvements, and we expect the full year operating margin to reach 3.7% on steady opex control of 4.4%. We are modelling for stable operating margin of 3.6-3.7%.

Fig 25 Operating income and margin Fig 26 R&D expense and ratio

(Rmbm) (Rmbm) 1,000 14% 1000 5% 12% 900 4% 800 800 10% 4% 600 700 3% 8% 600 3% 400 6% 500 2% 4% 400 200 300 2% 2% 1% - 200 0% 100 1% (200) -2% 0 0%

Operating Income OP margin (RHS) R&D expense R&D % sales ratio (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Moderate to high gearing ratio Q Tech borrows short-term loans to fund working capital and capex. We forecast net debt to equity ratio will increase from 51% in 2018 to 66% in 2019, but decline to 51% in 2020 and 34% in 2021 as the company improves operating cash flows.

The company hasn’t been able to consistently generate positive free cash flows due to increasing capex spending in recent years, but the product mix was sub-par due to share gain strategy. It expects equipment capex in 2019 to reach Rmb700m and budgeted Rmb200m for the Newmax capital injection subscription. We expect Q Tech’s capex spending in 2020 and 2021 to moderately decline as the pace of capacity expansion slows, which allows the company to generate positive free cash flows in the coming years. It has enough factories and land in Kunshan to expand capacity in the future, in our view.

5 November 2019 85 Macquarie Research Global smartphones

Fig 27 Cash position Fig 28 Free cash flows

(Rmbm) (Rmbm) 1800 250% 2500 1600 2000 1400 200% 1200 1500 1000 150% 1000 800 100% 600 500 400 50% 200 0 0 0% -500 -200 -400 -50% -1000 -1500 2011 2012 2013 2014 2015 2016 2017 2018 2019E2020E2021E

Net debt (cash) Net debt to equity Operating Cashflow Capex FCF

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Net fixed asset turns The company’s net fixed asset turnover declined significantly in 2018 due to customer strategy and product mix issues. With market share gain in high-end camera modules and increasing higher- ASP under-display fingerprint modules in the mix, we expect net fixed asset turnover to improve.

Fig 29 Capex Fig 30 Net fixed asset turns

(Rmbm) (x) 1,000 16% 12.0 900 14% 800 10.0 12% 700 600 10% 8.0 500 8% 6.0 400 6% 300 4% 4.0 200 2% 100 2.0 - 0% - 2011 2012 2013 2014 2015 2016 2017 2018 2019E2020E2021E

Capex Capex % of sales Net fixed asset turns

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Dividend policy Q Tech doesn’t have a fixed dividend policy but in general pays dividend during a good year. It paid out about 20% of net profit in 2016 and 2017 but decided to not pay dividend when it made an operating loss in 2018. We expect the company to pay dividend in 2019 with operations turning around. ROE and ROIC are also rebounding in 2019 as the company returns to making operating profits. We expect ROE and ROIC to improve in 2020-21E on increasing ASP of the product lines with stable margins.

5 November 2019 86 Macquarie Research Global smartphones

Fig 31 Dividend and payout Fig 32 ROE and ROIC

(Rmb) (x) 0.18 25% 30% 0.16 0.14 20% 25% 0.12 15% 20% 0.10 0.08 15% 10% 0.06 10% 0.04 5% 0.02 5% - 0% 0% 2014 2015 2016 2017 2018 2019E 2020E 2021E

Dividend per share Dividend payout (RHS) ROE ROIC

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Valuation We initiate with Outperform and a 12-month target price of HK$12.90, based on 20x 2020E earnings, for an average 39% net income growth over 2020-21E, implying 23% upside potential. Our valuation is in line with Q Tech’s past 12-month average forward PE multiple and higher than the average between 2015 and 2016 due to client base and technology improvement.

Downside risks The US-China trade war has brought an increased level of uncertainty for end-user demand outside China. Q Tech has increasing exposure to Huawei due to market share gain and increasing producer demand with higher ASP. It is uncertain whether overseas consumers will keep purchasing Huawei’s new smartphones if they lose access to Google Play, and whether Huawei’s legacy devices would be allowed to extend access to Google Mobile Services. Market share reshuffle to Samsung would negatively impact Q Tech, as the company hasn’t been qualified to be in the Samsung supply chain yet. If that’s the case, Sunny Optical would be a better play due to exposure to Samsung’s camera module and handset lens set business.

Fig 33 PE chart Fig 34 PB and ROE chart

(x) (x) 50 10 25% 45 9 40 8 20% 35 7 30 6 15% 25 5 20 4 10% 15 3 10 2 5% 5 1 0

0 0%

Jul16 Jul17 Jul18 Jul19 Jul15

Apr15 Oct15 Oct17 Oct18 Oct19 Apr16 Oct16 Apr17 Apr18 Apr19

Jan15 Jan16 Jan17 Jan18 Jan19

Jul15 Jul16 Jul19 Jul17 Jul18

Apr17 Oct17 Apr18 Oct18 Apr19 Oct19 Apr15 Oct15 Apr16 Oct16

Jan15 Jan16 Jan17 Jan18 Jan19 PE 5x 12x PB 0.5x 1.5x 3x 5x 7x 20x 27x 34x ROE (RHS)

Source: Macquarie Research, Bloomberg, November 2019 Source: Macquarie Research, Bloomberg, November 2019

5 November 2019 87 Macquarie Research Global smartphones

Corporate Governance and Risk Score – 2nd quartile Our proprietary Macquarie Governance and Risk Score ranked Q tech in the 2nd quartile overall - 1st quartile (the best) in terms of corporate governance, and 3rd quartile in terms of risk. Q Tech is strong in terms of management background and adequate communications with investors. On the other hand, Q tech’s high customer concentration and financial result consistency remains an uncertainty.

Fig 35 Q tech – Macquarie Government and Risk Score

Source: Macquarie Research, November 2019

Fig 36 Peer valuation 3M Stock Company Ticker Mkt cap ADTO Price performance TP Upside Rec EPS Growth PE PB ROE (US$m) (US$m) (lcy) 1M 1Y (lcy) 2019E 2020E 2019E 2020E 2019E 2020E 2019E 2020E

5 November 2019 88 Macquarie Research Global smartphones

Fig 37 Q Tech model summary Shipment mix 2016 2017 2018 2019E 2020E 2021E Camera module Below 8MP 34% 29% 46% 39% 22% 16% 8MP 43% 23% 10% 9% 11% 13% 10-20MP 22% 36% 32% 40% 38% 24% Above 20MP 0% 0% 0% 10% 23% 37% Multi-cam, 3D 1% 12% 11% 3% 7% 10%

Total volume (m units) 177 173 264 387 460 541 Volume growth 80% -3% 53% 47% 19% 17% ASP (Rmb) 24.1 33.7 23.8 25.8 35.2 40.2 ASP growth 8% 40% -30% 8% 37% 14%

Fingerprint module Non-under-display 100% 100% 88% 48% 24% 14% Under-display 0% 0% 12% 52% 76% 86%

Total volume (m units) 21 81 108 107 120 133 Volume growth 292% 33% 0% 13% 11% ASP (Rmb) 34.2 25.2 17.0 28.5 33.1 32.8 ASP growth -26% -32% 67% 16% -1% Source: Company data, Macquarie Research, November 2019

Fig 38 Macquarie forecast vs Bloomberg Consensus 2019E 2020E 2021E Rmbm MQ Consensus Diff MQ Consensus Diff MQ Consensus Diff

Revenue 13,073 11,487 14% 20,257 13,916 46% 26,159 16,185 62% Gross profit 1,057 967 9% 1,655 1,199 38% 2,094 1,422 47% OP profit 489 452 8% 753 619 22% 930 762 22% Profit before tax 482 478 1% 738 627 18% 957 751 27% Net income 426 415 3% 635 548 16% 823 655 26% Margin Gross margin 8.1% 8.4% -0.4 pct pts 8.2% 8.6% -0.5 pct pts 8.0% 8.8% -0.8 pct pts OP margin 3.7% 3.9% -0.2 pct pts 3.7% 4.5% -0.8 pct pts 3.6% 4.7% -1.2 pct pts Net margin 3.3% 3.6% -0.4 pct pts 3.1% 3.9% -0.9 pct pts 3.1% 4.0% -1 pct pts Source: Macquarie Research, Bloomberg, November 2019

Fig 39 P&L summary (Rmbm) 2014 2015 2016 2017 2018 2019E 2020E 2020E

Revenues 2,161 2,202 4,991 7,939 8,135 13,073 20,257 26,159 COGS -1,809 -1,962 -4,569 -7,056 -7,782 -12,016 -18,602 -24,064 Gross profit 353 241 422 883 353 1,057 1,655 2,094 GM% -19% -12% -9% -13% -5% -9% -9% -9%

SG&A -45 -34 -51 -81 -100 -124 -192 -249 R&D -73 -74 -125 -270 -266 -444 -709 -916 Operating profit 234 133 247 532 -13 489 753 930 OPM% 11% 6% 5% 7% 0% 4% 4% 4%

Net interest -18 1 -1 1 -15 -80 -68 -67 Net investment income 0 0 0 -17 -25 51 56 62 Other income/(expense) 23 -19 -31 -7 54 -64 -60 -60 Profit before tax 239 115 215 510 1 482 738 957 PBT margin 11% 5% 4% 6% 0% 4% 4% 4%

Income tax -44 -13 -24 -73 13 -56 -103 -134 Minority interest 0 0 0 0 0 0 0 0 Net Profit 196 102 191 436 14 426 635 823 Net margin 9% 5% 4% 5% 0% 3% 3% 3% Source: Company data, Macquarie Research, November 2019

5 November 2019 89 Macquarie Research Global smartphones

Fig 40 Balance sheet summary (Rmbm) 2014 2015 2016 2017 2018 2019E 2020E 2020E

Cash & equivalents 553 282 65 465 100 112 349 517 Receivables 873 889 2,606 2,035 3,031 4,258 5,647 7,167 Inventory 142 209 799 688 704 1,292 1,680 2,128 Other current assets 375 156 224 959 394 407 407 407 Total current assets 1,943 1,537 3,694 4,147 4,229 6,070 8,082 10,219 Fixed assets 354 438 737 1,497 1,940 2,344 2,607 2,737 LT investments 0 0 0 258 229 412 412 412 Other non-current assets 6 16 89 198 41 75 75 75 Total non-current assets 360 454 826 1,953 2,211 2,832 3,094 3,224 Total assets 2,303 1,991 4,520 6,100 6,440 8,901 11,176 13,444

Short term debt 713 142 335 1,078 1,178 1,676 1,932 1,926 Payables 445 622 2,593 2,830 3,061 4,523 5,992 7,570 Other current liabilities 12 2 10 26 30 45 45 45 Total current liabilities 1,169 766 2,939 3,934 4,270 6,245 7,970 9,542 Long term debt 0 0 0 0 0 0 0 0 Other liabilities 9 7 14 20 66 83 83 83 Total LT liabilities 9 7 14 20 66 83 83 83 Total liabilities 1,178 773 2,952 3,955 4,336 6,328 8,053 9,625

Common stocks 1,124 1,218 1,568 2,146 2,103 2,573 3,123 3,819 Minority equity 0 0 0 0 0 0 0 0 Total equity 1,124 1,218 1,568 2,146 2,103 2,573 3,123 3,819 Total liabilities and equity 2,303 1,991 4,520 6,100 6,440 8,901 11,176 13,444 Source: Company data, Macquarie Research, November 2019

Fig 41 Cash flow (Rmbm) 2014 2015 2016 2017 2018 2019E 2020E 2021E

Profit before tax 239 115 215 510 1 482 738 957 Depreciation 31 42 63 135 234 275 338 370 Amortization 0 1 1 1 1 0 0 0 Change in net working capital 77 183 -278 1,525 -440 -354 -307 -391 Other adjustments -44 -16 -39 52 31 719 -103 -134 Total operating cash flow 304 324 -39 2,222 -173 1,123 665 801

Capex -158 -137 -409 -949 -522 -700 -600 -500 Acquisition 0 0 0 -275 0 -158 0 0 (Purchase) Sale of ST investment -1 1 -1 -12 1 0 0 0 (Purchase) Sale of LT investment 81 0 0 0 4 -24 0 0 Others 317 140 -20 -882 904 15 0 0 Total investment cash flow 239 4 -430 -2,119 387 -868 -600 -500

Increase (decrease) in debt -33 -654 -24 218 -346 -170 256 -6 Cash dividends 0 -42 0 -37 -92 0 -85 -127 Change in share capital 551 11 143 185 55 39 0 0 Others -550 67 127 -54 -201 -112 0 0 Total financing cash flow -33 -618 246 312 -584 -242 171 -133

Net cash flow 510 -290 -223 414 -370 12 237 168 FX change 1 19 5 -14 5 0 0 0 Net cash flow after FX change 511 -271 -217 400 - 365 12 237 168

Free cash flow (OCF - Capex) 145 187 -448 1,272 -694 423 65 301 Source: Company data, Macquarie Research, November 2019

5 November 2019 90 Macquarie Research Global smartphones

The quant model currently holds a marginally negative view on Q Attractive Displays where the Technology Group. The strongest style exposure is Price Momentum, company’s ranked based on indicating this stock has had strong medium to long term returns which often s

l the fundamental consensus a persist into the future. The weakest style exposure is Valuations, indicating t

n Price Target and this stock is over-priced in the market relative to its peers. e

Macquarie’s Quantitative m a Alpha model.

480/620 d n

u Two rankings: Local market Global rank in F (Hong Kong) and Global Consumer Durables & Apparel sector (Consumer Durables Quant % of BUY recommendations 67% (14/21) & Apparel) Local market rank Global sector rank Number of Price Target downgrades 0 Number of Price Target upgrades 6

LG Innotek 0.3 LG Innotek

Primax 0.2 Primax

Sunny Optical -0.2 Sunny Optical

Q Technology Group -0.5 Q Technology Group

Truly International Holdi… -1.2 Truly International Holdi…

Newmax Technology -1.8 Newmax Technology

O-Film (A-Share) -2.1 O-Film (A-Share)

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Valuations Growth Profitability Earnings Price Quality Momentum Momentum

LG Innotek LG Innotek 0.5 Primax Primax 0.3 Sunny Optical Sunny Optical 0.5 Q Technology Group Q Technology Group 0.9 Truly International Holdi… Truly International Holdi… -0.5

Newmax Technology NaN Newmax Technology

O-Film (A-Share) -0.2 O-Film (A-Share)

-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 -100% -50% 0% 50% 100% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return

What drove this Company in the last 5 years How it looks on the Alpha model Which factor score has had the greatest correlation with the company’s A more granular view of the underlying style scores that drive the alpha (higher is returns over the last 5 years. better) and the percentile rank relative to the sector and market. ⇐ Negatives Positives ⇒ Normalized Percentile relative Percentile relative Sales Revisions 3 Month 31% Score to sector(/620) to market(/535) Alpha Model Score -0.50 EBITDA Revisions 3 Month 29% Valuation -0.81 Price to Sales NTM 25% Growth -0.06 IRR Dividend Disc. Model 25% Profitability -0.80 Earnings Momentum -0.20 Number of Shares Increase… -24% Price Momentum 0.20 Turnover(USD) 125 Day -25% Quality -0.59 Capital & Funding -0.08 Volatility 250 Day -28% Liquidity -0.10 Turnover (USD) 250 Day -32% Risk -1.36 Technicals & Trading -0.20 -40% -20% 0% 20% 40% 0 50 100 0 50 100 0 0 1 1

5 November 2019 91 Macquarie Research Global smartphones

Q Technology Group (1478 HK, Outperform, Target Price: HK$12.90) Interim Results 1H/19A 2H/19E 1H/20E 2H/20E Profit & Loss 2018A 2019E 2020E 2021E

Revenue m 5,061 8,012 9,633 10,624 Revenue m 8,135 13,073 20,257 26,159 Gross Profit m 415 642 794 861 Gross Profit m 353 1,057 1,655 2,094 Cost of Goods Sold m 4,646 7,370 8,838 9,764 Cost of Goods Sold m 7,782 12,016 18,602 24,064 EBITDA m 353 444 549 594 EBITDA m 252 798 1,143 1,393 Depreciation m 134 141 164 174 Depreciation m 234 275 338 370 Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0 Other Amortisation m 1 0 0 0 Other Amortisation m 1 1 0 0 EBIT m 219 304 385 421 EBIT m 16 522 806 1,023 Net Interest Income m -18 -22 -31 -36 Net Interest Income m -15 -40 -68 -67 Associates m 25 26 28 29 Associates m -25 51 56 62 Exceptionals m 0 0 0 0 Exceptionals m 0 0 0 0 Forex Gains / Losses m -30 -30 -30 -30 Forex Gains / Losses m -45 -60 -60 -60 Other Pre-Tax Income m 5 4 2 1 Other Pre-Tax Income m 69 8 3 -3 Pre-Tax Profit m 200 282 354 384 Pre-Tax Profit m 1 482 738 957 Tax Expense m -19 -37 -53 -50 Tax Expense m 13 -56 -103 -134 Net Profit m 181 245 300 334 Net Profit m 14 426 635 823 Minority Interests m 0 0 0 0 Minority Interests m 0 0 0 0

Reported Earnings m 181 245 300 334 Reported Earnings m 14 426 635 823 Adjusted Earnings m 181 245 300 334 Adjusted Earnings m 14 426 635 823

EPS (rep) 0.16 0.21 0.26 0.29 EPS (rep) 0.01 0.37 0.56 0.72 EPS (adj) 0.16 0.21 0.26 0.29 EPS (adj) 0.01 0.37 0.56 0.72 EPS Growth yoy (adj) % nmf 268.4 66.5 36.4 EPS Growth (adj) % -96.8 2,848.0 49.1 29.6 PE (rep) x 664.4 22.8 15.3 11.8 PE (adj) x 672.4 22.8 15.3 11.8

EBITDA Margin % 7.0 5.5 5.7 5.6 Total DPS 0.00 0.07 0.11 0.32 EBIT Margin % 4.3 3.8 4.0 4.0 Total Div Yield % 0.0 0.9 1.3 3.8 Earnings Split % 42.4 57.6 47.3 52.7 Basic Shares Outstanding m 1,124 1,142 1,142 1,142 Revenue Growth % 57.8 62.6 90.3 32.6 Diluted Shares Outstanding m 1,125 1,143 1,142 1,142 EBIT Growth % nmf 417.7 76.1 38.5

Profit and Loss Ratios 2018A 2019E 2020E 2021E Cashflow Analysis 2018A 2019E 2020E 2021E

Revenue Growth % 2.5 60.7 55.0 29.1 EBITDA m 252 798 1,143 1,393 EBITDA Growth % -60.8 216.4 43.3 21.8 Tax Paid m 13 -56 -103 -134 EBIT Growth % -96.8 3,081.8 54.2 27.0 Chgs in Working Cap m -781 -354 -307 -391 Gross Profit Margin % 4.3 8.1 8.2 8.0 Net Interest Paid m -15 -40 -68 -67 EBITDA Margin % 3.1 6.1 5.6 5.3 Other m 358 775 -0 0 EBIT Margin % 0.2 4.0 4.0 3.9 Operating Cashflow m -173 1,123 665 801 Net Profit Margin % 0.2 3.3 3.1 3.1 Acquisitions m 0 -158 0 0 Payout Ratio % 0.0 20.0 20.0 45.0 Capex m -522 -700 -600 -500 EV/EBITDA x 46.8 12.7 9.0 7.4 Asset Sales m 0 0 0 0 EV/EBIT x -1,309.1 18.8 12.5 10.0 Other m 908 -10 0 0 Investing Cashflow m 387 -868 -600 -500 Balance Sheet Ratios Dividend (Ordinary) m -92 0 -85 -127 ROE % 0.7 18.2 22.3 23.7 Equity Raised m 0 0 0 0 ROA % 0.3 6.8 8.0 8.3 Debt Movements m -346 -170 256 -6 ROIC % 6.4 14.5 16.8 18.7 Other m -146 -72 0 0 Net Debt/Equity % 51.3 60.8 50.7 36.9 Financing Cashflow m -584 -242 171 -133 Interest Cover x 1.1 12.9 11.9 15.4 Price/Book x 4.5 3.8 3.1 2.5 Net Chg in Cash/Debt m -365 12 237 168 Book Value per Share 1.9 2.3 2.7 3.3 Free Cashflow m -694 423 65 301

Balance Sheet 2018A 2019E 2020E 2021E

Cash m 100 112 349 517 Receivables m 3,031 4,258 5,647 7,167 Inventories m 704 1,292 1,680 2,128 Investments m 229 412 412 412 Fixed Assets m 1,940 2,344 2,607 2,737 Intangibles m 1 5 5 5 Other Assets m 433 477 477 477 Total Assets m 6,440 8,901 11,176 13,444 Payables m 3,061 4,523 5,992 7,570 Short Term Debt m 1,178 1,676 1,932 1,926 Long Term Debt m 0 0 0 0 Provisions m 0 0 0 0 Other Liabilities m 97 129 129 129 Total Liabilities m 4,336 6,328 8,053 9,625 Shareholders' Funds m 2,103 2,573 3,123 3,819 Minority Interests m 0 0 0 0 Other m 0 0 0 0 Total S/H Equity m 2,103 2,573 3,123 3,819 Total Liab & S/H Funds m 6,440 8,901 11,176 13,444

All figures in Rmb unless noted. Source: Company data, Macquarie Research, October 2019

5 November 2019 92

5 November 2019 Hong Kong

EQUITIES AAC Technologies (2018 HK) AAC – Revenue and gross margin forecasts Awaiting market recovery (Rmbm) 25,000 45% 40% Key points 20,000 35% 30% 15,000  We initiate with a Neutral rating and a 12-month target price of HK$52.20, 25% based on 20x 2020E EPS. Our target price implies 1.4% upside. 20% 10,000 15%  Business is still under transition with another year of share loss of high $- 5,000 10% content iPhone haptics, offsetting volume growth from Android customers. 5% - 0%  We forecast 2019 net income to decline by 47%, but to recover in 2020-21 2014 2015 2016 2017 2018 2019E 2020E 2021E with 38% and 17% growth driven by increasing sales to Android customers.

Revenue GM% (RHS)

Source: Company data, Macquarie Research, November 2019 The smartphone market has been unfavourable to AAC 2018 HK Neutral Price (at 14:33, 01 Nov 2019 GMT) HK$51.50 The global smartphone market, especially China, has been very weak in the past two years; Apple’s market share (AAC’s largest customer) has been declining. Valuation HK$ 52.20 Market appetite for acoustic and haptic upgrade has been very weak, as brands - PER 12-month target HK$ 52.20 mostly focused on camera and display upgrade. The market became even more Upside/Downside % +1.4 challenging for AAC when Apple introduced Luxshare in the acoustic and haptic 12-month TSR % +3.7 supply chain, which impacted AAC’s scale and margin. Volatility Index High Product mix diversification GICS sector Technology Hardware & Equipment AAC focused on two strategies to transition through the challenging times: Market cap HK$m 61,634 product diversification and improving the technology and economics of product Market cap US$m 7,865 offerings to Android smartphones. The company increased its R&D to sales ratio Free float % 59 to develop smartphone optics and transformed haptic production line to make

30-day avg turnover US$m 59.3 stepping motor for pop-up cameras. AAC also launched an upgraded acoustic Number shares on issue m 1,197 platform (SLS) for Android customers with tiered pricing (US$0.80-2.00),

providing performance enhancement at reasonable pricing. Investment fundamentals Year end 31 Dec 2018A 2019E 2020E 2021E 5G drives overall demand recovery, but Android is the key Revenue m 18,131 17,645 20,210 21,837 EBIT m 4,265 2,232 3,113 3,632 5G replacement cycle in the coming five years should turn around the sluggish EBIT growth % -29.9 -47.7 39.5 16.7 smartphone demand. Smartphone brands are fighting for market share and Reported profit m 3,796 1,999 2,767 3,235 AAC’s components are well-positioned to help increase product differentiation: Adjusted profit m 3,832 2,020 2,767 3,235 EPS rep Rmb 3.11 1.65 2.29 2.68 pop-up camera, x-axis haptic with curved OLED display, improved acoustic EPS rep growth % -28.7 -46.8 38.5 16.9 performance for better DXOMARK ranking, etc. AAC has been seeing good EPS adj Rmb 3.14 1.67 2.29 2.68 progress with Android in 2019. We believe the key driver of AAC’s growth will be EPS adj growth % -28.2 -46.7 37.0 16.9 PER rep x 14.9 28.0 20.2 17.3 the adoption of these components in the high-volume mid-range smartphone PER adj x 14.7 27.7 20.2 17.3 segment. Total DPS Rmb 1.24 0.84 1.11 1.29 Total div yield % 2.7 1.8 2.4 2.8 Initiate with Neutral rating ROA % 14.1 7.3 9.5 10.5 ROE % 21.0 10.6 14.0 15.1 Although we are seeing a glimpse of the light at the end of the tunnel, we are not EV/EBITDA x 9.9 13.1 10.7 9.9 there yet. In 2019, volume share loss to Luxshare is still affecting growth; 5G Net debt/equity % 9.5 8.3 1.4 -6.7 component cost increase in smartphone might be a risk factor for acoustic and P/BV x 3.0 2.9 2.7 2.5 haptic upgrade. We forecast net income to decline 47% in 2019 before recovering Source: FactSet, Macquarie Research, November 2019 (all figures in Rmb unless noted, TP in HKD) to +38% and +17% YoY in 2020-21E. We initiate on AAC with a Neutral rating and 12-month target price of HK$52.20 based on 20x 20E EPS.

Analysts Near term catalyst/key risk: 3Q result could deliver positive surprise on better Macquarie Capital Limited iPhone 11 sales. Key risks are slower adoption of AAC’s acoustics, haptics, Cherry Ma +852 3922 5800 [email protected] stepping motor and optics in Android devices; slowdown in Android smartphone sales; and a delay in component upgrades. Nicolas Baratte +852 3922 5801 [email protected] Fundamental catalyst: Increasing adoption of AAC’s components in Androids for

differentiated user experience in the medium term. 5 November 2019 93 Macquarie Research Global smartphones

Inside AAC Technologies

Company profile Awaiting market recovery 95 Founded in 1993 and headquartered in Shenzhen, China, AAC Technologies is a Surviving in an unfavourable market 96 specialist in manufacturing components with electro-magnetic and precision Transition ongoing 100 mechanical structures, including miniaturised acoustics (dynamics and mems Initiate coverage with Neutral 105 mic), haptics, stepping motor module and casing (electromagnetic drives and precision mechanics), optical lens set and RF/Antenna (others), mainly for smartphone and wearable applications. Apple is the largest customers with 50- Revenue mix by customers 60% revenue share, per our estimates. Korean customers Overall industry development in the past two years has not been favourable to 10% AAC. First, global smartphone growth slowed to 2.7% in 2017 and 1.2% 2018 per Gartner, while China declined by -11% and -16% per CAICT. Second, the lack of major upgrades in smartphone acoustics and haptics has caused pricing and margin pressure and increasing competition for AAC. AAC diversified to Chinese producing other components including smartphone plastic lenses in 2017 and customers 32% Apple stepping motor for pop-up camera in 2019. We expect net income to decline by 58% 47% in 2019 on sales decline and margin erosion, but to rebound by 38% in 2020 and 17% in 2021E on increasing adoption of AAC’s acoustic, haptics, stepping motor and plastic lenses by Android customers, driving scale improvement and margin recovery. Source: Company data, Macquarie Research, November 2019 Revenue by product mix (2019E) Fig 1 AAC’s revenue and gross margin

Optics Other (Rmbm) 6% 1% 25,000 45% 22,500 40% 20,000 35% 17,500 30% 15,000 25% Electromag 12,500 Dynamics 20% netic drives 10,000 46% and 7,500 15% precision 5,000 10% mechanics 2,500 5% 42% - 0% 2014 2015 2016 2017 2018 2019E 2020E 2021E Other Optics MEMS Electromagnetic drives and precision mechanics MEMS 5% Dynamics Gross margin Source: Company data, Macquarie Research, November Source: Company data, Macquarie Research, November 2019 2019

PE chart

Rmb Fig 2 2018 HK rel HSI performance, & rec history

140 120 100 80 60 40 20

Nov-08 Nov-09 Nov-10 Nov-13 Nov-14 Nov-17 Nov-18 Nov-11 Nov-12 Nov-15 Nov-16

May-10 May-11 May-12 May-14 May-15 May-16 May-19 May-08 May-09 May-13 May-17 May-18

Price 10x 15x 20x 25x 30x Source: Company data, Bloomberg, Macquarie Research, November 2019

Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, November 2019 (all figures in Rmb unless noted, TP in HKD)

5 November 2019 94

Macquarie Research Global smartphones

Awaiting market recovery

Investment summary

Global smartphone volume Unfavourable market conditions in 2017-18

(m units) 2,000 60% • Weak global smartphone volumes; Apple’s volumes and market share declining.

1,500 40% • Android smartphone OEMs are focusing on camera, fingerprint, display, casing upgrades; 1,000 20%

500 0% OEMs and consumers have limited interest in upgrading acoustics or haptics. - -20% • Apple has been focusing on cameras and casing colour in the past two years and largely

Smartphone IDC Smartphone Gartner ignored upgrades to haptic and acoustic. Apple also introduced Luxshare to the supply chain, YoY Gartner YoY IDC which diluted AAC’s volume share. Source: Gartner, IDC, Macquarie Research, November 2019 Product mix diversification to counterbalance demand weakness

• AAC diversified to other components based on its capabilities. AAC has transformed its haptic production line to make stepping motor modules for pop-up cameras. Stepping motor shares production and technology know-how with haptics. AAC has also increased investment in smartphone lenses.

5G to drive demand recovery • To encourage Android adoption in AAC’s components, the company has upgraded its acoustic

(m units) technology for Android with SLS solutions at a desirable price range of US$0.80-2.00, and cost 1,800 1,600 down entry level haptic solution to US$1.00-1.50. 1,400 1,200 1,000 800 600 Demand outlook positive on 5G, but AAC’s future depends on Android adoption 400 200 0 • We forecast global smartphone to recover and grow by +0.5%, +2.6% and +4.0% to 1.53bn, 1.54bn and 1.58bn units over 2020-21-22E, driven by 5G.

3G 4G 5G • By brand Source: Gartner, Macquarie Research, November 2019  Apple: better than expected demand for the iPhone 11 series due to camera upgrades and revised pricing. iPhone total volume recovery in 2020 on 5G upgrade.

 Market share shifts between Huawei and other Android brands should have a neutral impact on AAC. They are all AAC’s customers.

• Brands’ pursuit of product differentiation should drive adoption of AAC’s components.

AAC’s Android acoustic mix • Pop-up camera is a solution that improves the overall aesthetic of a smartphone to achieve a to improve full-screen viewing experience. We tracked 132 new smartphones launched by top brands in

100% 2019; about 26 models adopted the pop-up camera design. We model AAC to ship 20m and 10% 3% 11% 22% 80% 22% 48% 38m units in 2019 and 2020, contributing Rmb577m and Rmb990m of revenue. 60% 42% 90% 40% 58% • Acoustic quality upgrade is not as consumer driven as camera upgrades. We think brands’ 48% 20% 35% pursuit of product differentiation and the introduction of acoustic scoring benchmark by 0% 9% 2018 2019E 2020E 2021E DXOMARKS would eventually drive acoustic upgrade demand. In 2019, SLS adoption has Traditional SLS Gen 1 progressively improved within AAC’s product mix (1Q: 35% and 2Q: 50%). We model acoustic SLS Gen 2 SLS Gen 3 Source: Company data, Macquarie revenue contribution from Android to reach Rmb3.76bn, Rmb5.18bn and Rmb6.92bn in 2019- Research, November 2019 20-21E.

• Haptics has been used in premium devices (Vivo Nex 3 and Huawei Mate 30 Pro) to pair with the “waterfall” display, which is an OLED screen that curves towards the long edges of the device eliminating side volume buttons. We model Android haptic revenue to reach Rmb152m, Rmb308m and Rmb360m in 2019-20-21E on increasing penetration. Increasing optics revenue contribution • Optics: we believe the company’s short term tactic is to invest in capacity and produce as many

(Rmbm) lenses as they can to accumulate know-how and overcome the learning curve. We estimate 2,000 18% 16% optics revenue to grow by a three-year CAGR of 44%, driven by increasing penetration of triple 1,500 14% 12% and quad cameras in the market and AAC’s quality improvement in 4-5p plastic lenses. 10% 1,000 8% 6% Valuation 500 4% 2% - 0% We initiate with a Neutral rating and a 12-month target price of HK$52.20, based on 20x 2020E 2017 2018 2019E2020E2021E Optics revenue GM% (RHS) EPS. Our target price implies 1.4% upside. Source: Company data, Macquarie Research, November 2019

5 November 2019 95 Macquarie Research Global smartphones

Surviving in an unfavourable market

Overall market demand has been weak The global smartphone market, especially China, has been very weak in the past two years. Depending on the data source, global smartphone volume growth slowed to 2.7% in 2017 and 1.2% 2018, per Gartner, or was in a declining state of -0.3% and -4.0%, per IDC. According to CAICT, China smartphone volume has declined from the peak of 521m units in 2016 to 462m (-11% YoY) in 2017 and 390m units in 2018 (-16% YoY). In the first nine months of 2019, China demand continued to decline by -4.2% YoY.

Fig 3 Global smartphone volume and growth Fig 4 China monthly smartphone volume and growth

(m units) (m units) 1,800 50% 70 40%

1,600 60 30% 40% 1,400 20% 50 1,200 30% 10% 1,000 40 20% 0% 800 30 -10% 600 10% 20 -20% 400 0% 10 -30% 200 - -10% 0 -40% 2011 2012 2013 2014 2015 2016 2017 2018

Smartphone IDC Smartphone Gartner

YoY Gartner YoY IDC China smartphones YoY (RHS)

Source: IDC, Gartner, Macquarie Research, November 2019 Source: CAICT, Macquarie Research, November 2019

AAC’s largest client not doing well We estimate that Apple accounted for 55-60% revenue in 2018, followed by Chinese customers 30% and Samsung 10%. In the declining smartphone market, top Chinese smartphone brands, Huawei, Oppo, vivo and Xiaomi have been consolidating market share domestically and outside China. The top four Chinese brands in aggregate accounted for about 40% of market share in 1H19, Samsung’s share has stabilised at around 19-20%, but AAC’s largest customer Apple’s market share is still declining, to about 11% in 1H19.

Fig 5 Huawei, Oppo, vivo, Xiaomi global market share Fig 6 Samsung and Apple market share declining

45% 35% 40% 31% 35% 30% 30% 29%

25% 25% 25% 20% 23% 15% 21% 21% 20% 20% 10% 19% 19%

5% 16% 15% 15% 16% 14% 0% 14% 13% 11% 10% 2012 2013 2014 2015 2016 2017 2018 1H19

HOvX - China HOvX - Overseas Samsung Apple

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 96 Macquarie Research Global smartphones

Declining demand in acoustic upgrade from iPhone and Android In the early smartphone era, Apple products provided design inspirations for Chinese Android smartphone brands. The following figures showed that in early 2016, Oppo launched the R9 Plus, which largely resembled the iPhone 6S Plus launched in late 2015. While the exterior (casing and colour) looks similar to the iPhone, the internal components were not necessarily the same. Big hardware trends that Android adopted following Apple’s suit were plastic to aluminium casing upgrade, fingerprint sensor and most recently true wireless earbuds.

Fig 7 Oppo R9 Plus (left) vs iPhone 6S Plus (right) Fig 8 Oppo Reno 2 (left) vs iPhone 11 Pro (right)

Source: GSMArena, Macquarie Research, November 2019 Source: GSMArena, Macquarie Research, November 2019

Specs preference differences between iPhone and Android Specs that Apple cared about and upgraded (between 2015-2017) but Android had largely ignored were acoustic upgrades, tactile feedback through haptics, water/dust proofing and 3D sensing facial recognition. Adding up these features could cost the OEMs about US$50 more per phone. The Android specs upgrade trend hasn’t been favourable to AAC. Specs that Android sought after were mainly camera upgrades, longer battery life, larger display ratio, under-display fingerprint sensor and 3D glass design. Android’s preference of specs upgrade were not benefiting AAC. Also, consumer surveys conducted by research firms in the past few years suggest that longer battery life, durability, a better camera are often what consumers seek in smartphone devices. Acoustic and haptic abilities are often not regarded in making the purchase decision, as it’s not easy for a consumer to quantify and judge the quality of sound and sensitivity of tactile feedback.

Apple slowed down spec upgrades and subsequently introduced more competition iPhone’s acoustic upgrades and haptic adoption drove AAC’s revenue to achieve a three-year CAGR of 33% between 2015 and 2017. However, since Android brands were not chasing Apple’s acoustic and haptic upgrade, we believe there was much less incentive for Apple to keep upgrading those components. Also, Apple introduced Luxshare (through the JV Meite with Merry Electronics, which was already in the supply chain) in acoustics manufacturing in 2017 and in the haptic supply chain in 2018. With limited specs changes in 2018 and 2019, Luxshare was able to ramp up and improve its learning curve quickly. As a result, with declining ASP and lower scale due to declining allocation and iPhone 8-X and Xs/XR cycles not selling well, AAC’s gross margin dropped below the company’s long-term target of 40% since 1Q18.

Market share loss, but not due to AAC’s technology capability AAC did not lose market share due to technology weakness. In the iPhone supply chain, technology innovation is mostly dictated by Apple. Apple might not necessarily be looking for the best component nor upgrading every year. We believe AAC lost market share because Apple was looking to balance the market share between AAC, Goertek and Luxshare on acoustic, and AAC, Alps, Nidec, Luxshare on haptics. Limited product upgrades also help new suppliers to overcome the learning curve and catch up.

5 November 2019 97 Macquarie Research Global smartphones

Fig 9 AAC’s revenue and gross margin Fig 10 AAC’s acoustic and non-acoustics revenue

(Rmbm) (Rmbm) 25,000 45% 12,000

40% 10,000 20,000 35%

30% 15,000 8,000 25%

20% 6,000 10,000 15% 4,000 5,000 10% 5% 2,000 - 0% 2014 2015 2016 2017 2018 1H19 - 2014 2015 2016 2017 2018 Revenue GM% (RHS) Acoustics Non-acoustics

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Onto the next When life gives you lemons, make lemonade. As AAC kept losing market share to Luxshare as Apple further diversified the supply chain, the company had to evaluate options based on its core capability. It focused on two strategies to survive through the challenging times: product diversification and improving the technology and economics of product offerings to Android smartphones. In 2018 and 1H19, AAC continued to increase its R&D spending to sales ratio to focus on technology and building up new capabilities.

Fig 11 AAC’s R&D spending and % sales ratio

(Rmbm) 1,800 11% 12.0% 1,600 10.0% 8.3% 1,400 7.9% 7.4% 7.3% 7.5% 1,200 8.0% 1,000 6.0% 800 600 4.0% 400 2.0% 200 - 0.0% 2014 2015 2016 2017 2018 1H19

R&D expense R&D % sales ratio (RHS)

Source: Company data, Macquarie Research, November 2019

5 November 2019 98 Macquarie Research Global smartphones

Diversifying to other components based on its capabilities

Handset lens set Plastic lens production is largely know-how based and outside of AAC’s traditional core capabilities. However, AAC was able to leverage its skill set in moulding. In acoustics, a speaker is assembled by multiple parts; AAC designs the parts and the mould to produce the parts. Mould design requires high level of precision, and it is a transferrable skill that AAC has leveraged on in lens manufacturing. AAC commenced mass production of plastic lens in 2017 with Rmb162m revenue contribution, followed by a 240% YoY growth in 2018 to Rmb550m. Besides plastic lenses, AAC has also developed wafer level glass (WLG) lens technology to revolutionise the manufacturing processes of miniaturised glass lenses.

Stepping motor module AAC’s core capability is designing and manufacturing miniature components based on electromagnetic technology. Besides speakers and receivers, haptic motor and stepping motor modules for pop-up camera design are based on the same technology and similar manufacturing processes. As AAC designs its production line to be flexible and interchangeable, when iPhone haptic orders started declining, AAC was able to switch some of the production lines to produce stepping motors in 2019.

Upgrading technology and economics of existing products for Android Android brands are frugal when it comes to component technologies that are outside of their top priorities, i.e. acoustics and haptics. While we estimate Apple pays US$6 per set of iPhone acoustics and US$7 for haptics, Android brands have a budget of about US$1.00-2.00 per acoustic set and may have limited interest in haptics. Therefore, in order to increase the product attractiveness and encourage adoption, AAC has to meaningfully upgrade the technology while keeping the price affordable.

• For acoustics, AAC designs a standardised Super Linear Speaker (SLS) product platform to reduce costs related to customisation. Gen-1 of the SLS product targets high-end and premium smartphones; Gen-2 gets performance enhancement at similar price and Gen-1 is cost-down for wider adoption. The company launched the first generation of the SLS platform in 1H18, followed by the second generation in 2019 and plans to launch the third generation by the end of 2019. AAC targets to gain market share in Android smartphones by providing the highest quality acoustic platform at the most competitive pricing.

• For haptics, AAC has designed low-cost haptics (US$1.00-1.50) for Android adoption. The first generation of haptics for Android cost US$3.50-4.00 in 2017 and adoption was quite muted due to the price point.

5 November 2019 99 Macquarie Research Global smartphones

Transition ongoing

Growth drivers • Market recovery  We forecast global smartphone volume to recover and grow by +0.5%, +2.6% and +4.0% to 1.53bn, 1.54bn and 1.58bn units over 2020-21-22E, driven by 5G.

• Improving adoption by Android brands  We believe the revenue growth for AAC’s acoustic, haptic and stepping motor solutions would be propelled by the increasing differentiation of Android smartphones.

 A three-year CAGR of 44% growth in AAC’s optics revenue will be driven by the increasing market demand for 4-5p lenses, but contribution to bottom line will be slower due to yield issues and overcoming production learning curve.

• iPhone refresh

 After limited acoustic upgrades in 2018-19, we expect a round of upgrades in the 2020 new iPhones.

 However, we model iPhone haptic revenue to decline in 2019-20-21E due to share loss to Luxshare and limited upgrades.

5G upgrade cycle to drive overall smartphone volume growth We believe 5G smartphones will create a wave of replacement demand in the coming five years. In 2019, new 5G smartphones have been launched by multiple Android brands in selected markets. In 2020, Qualcomm and MediaTek plan to have 5G chipsets ready for mid-range smartphones. We forecast global smartphone volumes to decline by -1.7% in 2019 and recover and grow by +0.5%, +2.6% and +4.0% over 2020-21-22E. For AAC’s major customer, Apple, we expect iPhone volumes to decline by -12% in 2019 but recover by 9% in 2020 due to better than expected iPhone 11 series sales and 5G upgrade in 2H20.

AAC is neutral to market share shifts between Android brands The US-China trade ban and entity list have a neutral impact on AAC, as AAC works with Samsung, Huawei and other Chinese brands. The major driver for AAC would be the increasing overall adoption of SLS and haptics amongst mid-end smartphones.

Fig 12 Smartphone shipment by 3G/4G/5G technology Fig 13 Top six smartphone brands share consolidation

(m units) 1,800 90%

1,600 80%

1,400 70% 1,200 60% 1,000 42% 48% 50% 29% 35% 38% 800 17% 24% 40% 600 30% 16% 400 14% 14% 13% 12% 13% 12% 20% 200 23% 0 10% 21% 21% 19% 19% 18% 18% 0% 2015 2016 2017 2018 2019E 2020E 2021E

3G 4G 5G Samsung Apple HOVX

Source: Gartner, Macquarie Research, November 2019 Source: Gartner, Macquarie Research, November 2019

5 November 2019 100 Macquarie Research Global smartphones

Product differentiation of Android smartphones Pop-up camera is solution that improves the overall aesthetic of a smartphone to achieve full- screen viewing experience. It also helps brands to differentiate external design. We tracked 132 new smartphones launched by top brands in 2019, about 26 models adopted the pop-up camera design. We model AAC to ship 20m and 38m units in 2019 and 2020, contributing Rmb577m and Rmb990m of revenue.

Fig 15 Front-camera form factor in new smartphones Fig 14 Pop-up front camera in the Vivo Nex 3 sample

70% 57% 60%

50%

40%

30% 20% 20% 11% 6% 10% 4% 2% 0% Water drop Pop up Hole punch Fringe Top panel Full screen no cam Front camera

Source: Vivo, November 2019 Source: Macquarie Research, GSMArena, November 2019

Acoustic quality upgrade is not as consumer driven as camera upgrades. We think the brand’s pursuit of product differentiation would eventually drive acoustic upgrade demand. To accelerate this process, AAC has designed the super-linear-speaker platform that targets to lift acoustic performance dramatically, but to keep the cost low with tiered pricing (Gen 1, Gen 2 and Gen 3) ranging between approximately US$0.80 to US$2.00. In 2019, SLS adoption has progressively improved within AAC’s product mix (1Q: 35% and 2Q: 50%).

We believe another catalyst would be the availability of a benchmarking system to inform consumer on audio quality of the smartphones. In October 2019. DXOMARK, an independent benchmark that assesses smartphone cameras quality, has extended its coverage to assess smartphone’s audio recording and playback quality via the built-in speakers and mics.

Fig 16 DXOMARK scores on audio and main camera Launch date Current price (US$) Audio Main camera

Huawei Mate 20X Oct-18 8851 75 1122* Apple iPhone XS Max Sep-18 999 74 106 Apple iPhone 11 Pro Max Sep-18 1,099 71 n/a Samsung Galaxy Note 10+ Aug-19 1,000 66 1173 Samsung Galaxy S10+ Feb-19 950 65 113 Honor 20 Pro May-19 420 53 113 Sony Xperia 1 Feb-19 850 45 94 Source: DXOMARK, Company data, Best Buy, Macquarie Research, November 2019 1price of Mate 20X 5G, 2score of Mate 20 Pro which has the same specs as Mate 20 X, 3score of Note 10+ 5G which has the same specs as Note 10+

We have collated the audio scores of the smartphones DXOMARK tested on and compared with their corresponding main camera score, current price and product launch date. What we found, which was not surprising, was that most of these smartphones have top ranking main camera scores, but vary widely in the audio department. According to the benchmark, Huawei Mate 20X, a flagship model from 2018, has a slightly better score than the iPhone XS Max and iPhone 11 Pro Max. Per our understanding, iPhone Xs and 11’s speakers didn’t get a major upgrade compared to the X cycle (2017), while Huawei Mate 20X uses AAC’s first generation SLS solution launched in 2018. With such a stark contrast between main camera and audio scores, we believe smartphone brands can find more room to differentiate their device and have more incentive to upgrade their speakers. We model acoustic revenue contribution from Android to reach Rmb3.76bn, Rmb5.18bn and Rmb6.92bn in 2019-20-21E. 5 November 2019 101 Macquarie Research Global smartphones

Fig 17 Android acoustic product mix and ASP estimates

(US$) 100% 1.60 10% 3% 11% 90% 22% 1.40 80% 22% 1.20 70% 48% 60% 1.00 42% 50% 0.80 90% 40% 58% 0.60 30% 48% 0.40 20% 35% 10% 0.20 9% 0% 0% - 2018 2019E 2020E 2021E

Traditional SLS Gen 1 SLS Gen 2 SLS Gen 3 ASP

Source: Company data, Macquarie Research, November 2019

Haptics has been a premium component in the iPhone devices, delivering sensitive tactile touch and feedback experiences. For Android smartphone OEMs, haptic has been low on the component adoption list as it’s viewed as a “good to have” solution that costs a few US dollars that consumers generally don’t have an opinion about. However, in 2019, we started seeing x-axis haptics being adopted in premium devices (Vivo Nex 3 and Huawei Mate 30 Pro) to pair with the “waterfall” display, which is an OLED screen that curves towards the long edges of the device eliminates side volume buttons. The haptic motor would be able to provide users with tactile feedback that mimics the volume buttons, alongside with an overall user experience upgrade of tactile feedback in varies use cases. We model Android haptic revenue to reach Rmb152m, Rmb308m and Rmb360m in 2019-20-21E on increasing adoption.

Fig 18 Vivo Nex 3 X-axis haptic - Hidden pressure-sensing button + X-axis linear motor Fig 19 Huawei’s Mate 30 Pro X-axis haptic

Source: Company data, November 2019 Source: Company data, Macquarie Research, November 2019

Robust lens demand driven by increasing multi-cam penetration Camera upgrade is one of the top priorities for smartphone makers. Demand has been growing strongly in the past 5 years, driven by resolution upgrade in single camera and onto dual, triple and quad cameras with specs upgrade. We estimate there were 3.62bn sets of lens or 2.4 cameras per device in 2018, and the increasing triple and quad camera penetration in the next 2 years will drive total lens demand to 4.85bn and 5.62bn sets in 2020E and 2021E. The market presents significant growth opportunities. Largan, the plastic lens industry leader, has capacity expansion plan for 2023; Sunny Optical has ongoing capacity expansion. AAC started generating lens revenue in 2017, despite low profitability due to scale and yield issues, AAC is on the right track to gain production experience, make improvements and increase scale. 5 November 2019 102 Macquarie Research Global smartphones

Fig 20 Smartphone lens demand forecast Fig 21 AAC’s optics revenue and shipment estimates

(m units) (units per (Rmbm) phone) (m sets) 6,000 3.8 4.0 600 160 3.3 3.5 140 500 5,000 2.9 3.0 120 4,000 2.4 400 2.2 2.5 100 2.1 3,000 2.0 300 80 60 1.5 200 2,000 40 1.0 100 1,000 20 0.5 - - 0 - 2017 2018 1H19 2016 2017 2018 2019E 2020E 2021E

Total lens demand Camera per phone Optics revenue Volume (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Investing in capacity now… and could eventually pay off In 1H19, AAC’s lens revenue increased by over 70% YoY with shipment doubling YoY, per our estimates. However, due to yield issues, we believe the segment is still loss making. We believe the company’s short term tactic is to invest in building capacity to produce as many lenses as they can to accumulate know-how and overcome the learning curve. While Largan focuses on the premium market and Sunny focuses on the mid-range to high-end market, AAC has plenty of opportunities to scale up in the mid-range to low-end market due to the increasing market demand for standard lenses for the supporting lens of the multi-cam. AAC targets to ship 60m lens set per month by 2019 year-end.

Margin improvements could take several years Per our checks with a camera module maker in China, AAC’s plastic lens quality has been improving progressively. From Sunny Optical’s experience, organic margin improvement was 2-3 pct pts per year prior to the Konica Minolta cooperation, and the breakthrough after the cooperation helped Sunny to improve its optical component gross margin by 13 pct pts in 2 years. For AAC, through organic growth, we think the plastic lens business will take several years to see meaningful margin improvements. We believe AAC’s strategy in plastic lens will eventually pay off, once yield rate stabilises and utilisation rate improves.

Fig 22 Sunny Optical’s handset lens volume and segment gross margin

(m sets) 1000 50% 900 800 45% Konica Minolta: 700 patents & 40% 600 production know 500 how 35% 400 300 30% 200 25% 100 0 20% 2012 2013 2014 2015 2016 2017 2018

Sunny Optical's handset lens shipment Optical component gm% (RHS)

Source: Company data, Macquarie Research, November 2019

5 November 2019 103 Macquarie Research Global smartphones

Lens technology upgrade The plastic lens leaders Largan and Sunny are now working on 8P in their lens upgrade roadmap. AAC’s product mix is still mainly 4-5p and has not commenced mass production on 6p yet. Instead of chasing the technology leaders by catching up on 7P plastic lenses, AAC prefers to approach the high-end market with hybrid lenses using its WLG technology, where its disruptive production technology could provide higher yield rate and output. While hybrid lens provide better light penetration due to the property of glass, the precision requirement for both WLG lens and plastic lens are high, while hybrid lens assembly is also more challenging than traditional plastic lens. The current market appetite for hybrid lenses is still small, as Largan and Sunny’s plastic lens technology satisfy specs upgrade demands. However, we might see hybrid lens in the market due to the heat issues in the camera module; glass has higher heat resilience than plastic to deliver stable image quality. AAC is preparing to commence mass production for 1-2m set of WLG lenses by end of 2019/ early 2020.

5 November 2019 104 Macquarie Research Global smartphones

Initiate coverage with Neutral

Revenue growth We expect the overall revenue to show a three-year CAGR of 6% over 2019-20-21E.

• Overall acoustic revenue to show a three-year CAGR of 10% to Rmb8.1bn, Rmb9.7bn and Rmb11.4bn in 2019-20-21E, driven by Android acoustics upgrades to SLS. We expect iPhone acoustics to decline by 13% in 2019 on volume decline, followed by a +3% increase in 2020 and limited growth in 2021. We expect Android acoustics revenue to increase by 3%, 38% and 34% over 2019-20-21E driven by the increasing SLS adoption within AAC’s customer base. We model gross margin to improve steadily as production scale picks up.

Fig 23 AAC’s revenue and gross margin Fig 24 AAC’s acoustic revenue and gross margin

(Rmbm) (Rmbm) 25,000 45% 14,000 50%

40% 45% 12,000 20,000 35% 40% 10,000 35% 30% 15,000 30% 25% 8,000 25% 20% 6,000 10,000 20% 15% 4,000 15% 5,000 10% 10% 2,000 5% 5% - 0% - 0% 2014 2015 2016 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Revenue GM% (RHS) Acoustics GM% (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

• Non-acoustic revenue (haptics, stepping motor, casing) to decline by an average of 2% over the next three years due to share loss in iPhone haptics not offset by the growth in Android products. We expect revenue from iPhone haptics to decline by 33%, 6%, 16% over 2019-20- 21E on Apple’s supply chain diversification strategy. We expect haptics in other products, including Apple Watch and Android smartphones, to show a three-year CAGR of 35%, on increasing volumes for the Watch and increasing adoption of haptics in Android. We model metal casing revenue to grow by 13%, 4% and 0% in 2019-20-21E due to shipment growth limited to capacity cap and limited ASP growth on competitive market dynamics. We expect gross margin to stay flattish at 30% as metal casing business continues to be margin dilutive.

Fig 25 AAC’s non-acoustic revenue and gross margin Fig 26 AAC’s optics revenue and gross margin

(Rmbm) (Rmbm) 12,000 60% 1,800 18%

1,600 16% 10,000 50% 1,400 14%

8,000 40% 1,200 12%

1,000 10% 6,000 30% 800 8%

4,000 20% 600 6%

400 4% 2,000 10% 200 2%

- 0% - 0% 2014 2015 2016 2017 2018 2019E 2020E 2021E 2017 2018 2019E 2020E 2021E

Non-acoustics GM% (RHS) Optics revenue GM% (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 105 Macquarie Research Global smartphones

• Optics revenue to show a three-year CAGR of 44% to Rmb1.0bn, Rmb1.4bn and Rmb1.6bn with shipment volumes of plastic lenses to increase from 140m sets in 2018 to 340m, 447m and 537m sets in 2019-20-21E, driven by increasing penetration of triple and quad cameras in the market and AAC’s production improvement in 4-5p plastic lenses. We estimate gross margin to improve progressively to mid-teens by 2021E; we are conservative in our optics gross margin assumptions as we believe production know-how accumulation and de-bottlenecking takes time.

Operating income and margin We expect AAC’s operating income to decline by 48% YoY in 2019 due to gross margin decline and operating deleverage. AAC has kept R&D spending high, at 11% of sales in 1H19, despite slowing sales to develop the optics business. We expect operating income to increase by 35% and 58% in 2020 and 2021E on sales and gross margin recovery.

Fig 27 Operating income and margin Fig 28 R&D expense and ratio

(Rmbm) (Rmbm) 7,000 35% 2,500 12.0% 10.4% 29% 29% 10.2% 28% 27% 6,000 30% 9.2% 10.0% 2,000 8.3% 24% 7.9% 5,000 25% 7.4% 7.5% 7.3% 8.0% 1,500 4,000 16% 20% 15% 6.0% 3,000 13% 15% 1,000 4.0% 2,000 10% 500 1,000 5% 2.0%

- 0% - 0.0% 2014 2015 2016 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Operating Income OP margin (RHS) OPEX (RHS) R&D expense R&D % sales ratio (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Healthy gearing ratio, positive free cashflow AAC utilises short-term and long-term bank loans and operating cashflow to fund working capital and capex. Net debt to equity in 2018 reached 9%. We expect AAC to continue generating positive free cashflow in the future on narrowing capex spending.

Fig 29 Cash position Fig 30 Free cashflow

(Rmbm) (Rmbm) 13% 2,500 14% 8,000 12% 2,000 9% 6,000 9% 10% 1,500 8% 4,000 1,000 6% 2,000 2% 4% 500 2% 2% - - -2% 0% -4% (2,000) (500) -2% -5% -4% (1,000) (4,000) -6% (1,500) -8% (6,000) 2014 2015 2016 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Net debt (cash) Net debt to equity Operating Cashflow Capex FCF

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 106 Macquarie Research Global smartphones

Lower capex; net fixed asset turns should improve AAC’s capex-to-sales ratio has been declining from the peak of 25% in 2016 to 16% in 2018. We expect capex ratio to decline to 11%. The company expects to spend around Rmb2bn on capex in 2019 (-32% YoY), of which 30-35% on optics, 30% on other products (acoustics, haptics and casing), and 30-35% on infrastructure. Net fixed asset turnover has been declining from 1.9x between 2014 to 2017 to 1.3x in 2018 and our estimate of 1.1x in 2019, on declining revenue scale. With prudent capex spending, we expect capex ratio to decline and net fixed asset turns to improve when sales recover in 2020-21E.

Fig 31 Capex Fig 32 Net fixed asset turns

(Rmbm) (x) 6,000 30% 2.0 25% 1.9 1.9 1.9 24% 1.9 5,000 23% 25% 1.8 1.8 20% 1.7 4,000 20% 16% 1.6

3,000 15% 1.5 11% 1.4 10% 9% 2,000 10% 1.3 1.3 1.3 1.2 1.2 1,000 5% 1.1 1.1 1.0 - 0% 2014 2015 2016 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Net fixed asset turns Capex Capex % of sales

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Higher payout ratio Management has decided to increase the payout ratio in 1H19 to 55% from an average of 40% in the past five years to keep the dollar payout of HK$0.40 per share the same YoY. With strong operating cashflow, we expect AAC might keep the payout ratio at 55% to enhance shareholders’ return. The company’s ROE and ROIC had declined significantly in 2018 and 2019 due to lower revenue iPhone revenue scale and declining gross margin. We expect ROE and ROIC to improve slightly in 2020-21E but will not likely return to strong double digit due to the lower gross margin profile of the product mix.

Fig 33 Dividend and payout Fig 34 ROE and ROIC

(Rmb) 2.00 55% 55% 55% 60% 40%

1.80 35% 50% 1.60 41% 40% 40% 39% 40% 30% 1.40 40% 1.20 25% 1.00 30% 20%

0.80 15% 20% 0.60 10% 0.40 10% 0.20 5% - 0% 0% 2014 2015 2016 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Dividend per share Dividend payout (RHS) ROE ROIC

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

5 November 2019 107 Macquarie Research Global smartphones

Valuation We initiate with a Neutral rating and a 12-month target price of HK$52.20, based on 20x 2020E EPS. AAC’s past 6-month and past 12-month’s average forward PE were 19x and 21.6x. We believe our target multiple is justified as we expect an average of 28% EPS growth (Bloomberg consensus average 20%) in 2020-21E.

Risks Our revenue growth forecast is mainly based on the increasing adoption of AAC’s acoustics, haptics, stepping motor and optics in Android devices. Slowdown in overall Android smartphone sales, as well as delay in component upgrades will adversely affect our forecast. Our top pick within the smartphone supply chain are the camera names, including Largan, Sunny Optical and Q Tech, where we see a clearer specs migration roadmap.

Fig 35 PE chart Fig 36 PB and ROE chart

Rmb Rmb 200 35% 140 180 30% 120 160 140 25% 100 120 20% 80 100 15% 60 80 60 10% 40 40 5% 20 20 0 0%

Jul-09 Jul-16

Oct-14 Apr-11 Apr-18

Jun-12 Jan-13 Jun-19

Feb-10 Feb-17 Mar-14

Dec-08 Nov-11 Dec-15 Nov-18

Sep-10 Aug-13 Sep-17

May-08 May-15

Nov-08 Nov-09 Nov-10 Nov-11 Nov-16 Nov-17 Nov-18 Nov-12 Nov-13 Nov-14 Nov-15

May-08 May-09 May-10 May-11 May-16 May-17 May-18 May-19 May-12 May-13 May-14 May-15 Price 2x 3.5x

Price 10x 15x 5x 6x 7x

20x 25x 30x ROE (RHS)

Source: Company data, Macquarie Research, November 2019 Source: Company data, Macquarie Research, November 2019

Fig 37 Peer valuation 3M Stock Mkt cap ADTO Price performance TP EPS Growth PE PB ROE Company Ticker (US$m) (US$m) (lcy) 1M 1Y (lcy) Upside Rec 2019E 2020E 2019E 2020E 2019E 2020E 2019E 2020E

Luxshare* 002475 CH 24,936 251 32.81 23% 158% NR 28% 39% 43.2 31.0 8.6 6.9 22% 23% Largan 3008 TT 19,640 91 4,460.0 -2% 34% 5,000 12% O 20% 17% 20.8 17.8 4.7 4.0 25% 24% Sunny 2382 HK 18,108 103 129.40 12% 77% 163.56 26% O 37% 54% 37.5 24.3 10.5 7.7 32% 37% Goertek* 002241 CH 8,590 216 18.63 6% 154% NR 47% 34% 46.8 34.9 3.7 3.4 8% 10% AAC 2018 HK 7,940 54 51.50 24% -20% 52.2 1% N -47% 38% 28.0 20.2 2.9 2.7 11% 14% Merry* 2439 TT 1,012 18 150.00 -5% 7% NR 27% 11% 11.4 10.3 2.5 2.5 26% 26% Tongda* 698 HK 537 2 0.65 18% -35% NR 39% 20% 5.4 4.5 0.7 0.6 12% 13% Average 11% 54% 22% 31% 27.6 20.4 4.8 4.0 19% 21% Source: *Bloomberg Consensus, Macquarie Research, November 2019; priced as of 1 November 2019

5 November 2019 108 Macquarie Research Global smartphones

Fig 38 Revenue model by application Revenue by application (Rmb m) 2017 2018 2019E 2020E 2021E

Acoustics for iPhones 5,508 5,033 4,368 4,516 4,532 Acoustics for Android 4,072 3,642 3,762 5,182 6,921 Mems microphone 848 814 898 987 1,086 Haptics for iPhones 7,300 5,268 3,555 3,347 2,812 Haptics for others 321 469 856 1,045 1,142 Stepping motor - - 577 990 928 Metal casing 2,874 2,145 2,432 2,528 2,528 Handset lens 166 550 1,059 1,368 1,641 Others 29 210 247 247 247 YoY Acoustics for iPhones -9% -13% 3% 0% Acoustics for Android -11% 3% 38% 34% Mems microphone -4% 10% 10% 10% Haptics for iPhones -28% -33% -6% -16% Haptics for others 46% 82% 22% 9% Stepping motor 71% -6% Metal casing -25% 13% 4% 0% Handset lens 230% 93% 29% 20% Others 616% 18% 0% 0% Source: Company data, Macquarie Research, November 2019

Fig 39 Our estimates vs consensus 2019E 2020E 2021E Rmb m MQ Consensus Diff MQ Consensus Diff MQ Consensus Diff

Revenue 17,645 17,508 1% 20,210 19,371 4% 21,837 20,802 5% Gross profit 5,001 5,262 -5% 6,132 6,201 -1% 6,675 6,792 -2% OP profit 2,232 2,737 -18% 3,113 3,589 -13% 3,632 4,119 -12% Profit before tax 2,269 2,730 -17% 3,109 3,467 -10% 3,635 4,009 -9% Net income 1,999 2,375 -16% 2,767 3,025 -9% 3,235 3,429 -6% Margin Gross margin 28.3% 30.1% -1.8 pct pts 30.3% 32.0% -1.7 pct pts 30.6% 32.7% -2.1 pct pts Opex 15.7% 14.4% 1.3 pct pts 14.9% 13.5% 1.5 pct pts 13.9% 12.8% 1.1 pct pts OP margin 12.6% 15.6% -3 pct pts 15.4% 18.5% -3.2 pct pts 16.6% 19.8% -3.2 pct pts Net margin 11.3% 13.6% -2.3 pct pts 13.7% 15.6% -2 pct pts 14.8% 16.5% -1.7 pct pts Source: Company data, Macquarie Research, November 2019

Fig 40 P/L summary Rmb m 2014 2015 2016 2017 2018 2019E 2020E 2021E

Revenues 8,879 11,739 15,507 21,119 18,131 17,645 20,210 21,837 COGS -5,201 -6,867 -9,064 -12,399 -11,388 -12,644 -14,078 -15,162 Gross profit 3,678 4,872 6,443 8,720 6,743 5,001 6,132 6,675 GM% 41% 42% 42% 41% 37% 28% 30% 31%

SG&A -537 -803 -763 -975 -966 -931 -953 -1,028 R&D -656 -859 -1,166 -1,664 -1,512 -1,839 -2,066 -2,015 Operating profit 2,485 3,210 4,514 6,081 4,265 2,232 3,113 3,632 OPM% 28% 27% 29% 29% 24% 13% 15% 17%

Net interest 14 22 67 165 184 -228 -227 -228 Net investment income -1 -5 -9 -7 0 0 0 0 Other income 110 252 195 87 264 265 223 231 Profit before tax 2,581 3,435 4,633 5,996 4,310 2,269 3,109 3,635 PBT margin 29% 29% 30% 28% 24% 13% 15% 17%

Income tax -270 -325 -609 -671 -514 -270 -342 -400 Minority interest -7 3 -1 1 0 0 0 0 Net Profit 2,318 3,107 4,026 5,325 3,796 1,999 2,767 3,235 Net margin 26% 26% 26% 25% 21% 11% 14% 15% Source: Company data, Macquarie Research, November 2019

5 November 2019 109 Macquarie Research Global smartphones

Fig 41 Balance sheet Rmb m 2014 2015 2016 2017 2018 2019E 2020E 2021E

Cash & equivalents 1,603 2,224 3,864 4,034 4,126 4,308 5,661 7,377 Receivables 3,850 4,196 6,156 7,155 4,474 5,196 5,882 6,045 Inventory 1,267 1,718 2,623 3,398 3,319 4,371 4,814 4,931 Other current assets 30 43 186 20 65 67 67 67 Total current assets 6,750 8,181 12,829 14,607 11,985 13,942 16,424 18,420 Fixed assets 5,285 7,080 9,494 13,526 15,440 16,888 16,536 16,232 LT investments 380 386 400 752 205 203 203 203 Other non-current assets 864 774 1,534 1,837 2,239 510 510 510 Total non-current assets 6,529 8,239 11,428 16,115 17,884 17,601 17,250 16,946 Total assets 13,279 16,420 24,257 30,722 29,869 31,543 33,674 35,366

Short term debt 1,418 1,159 3,304 4,349 3,493 2,275 2,294 2,273 Payables 2,388 2,919 5,346 6,369 4,548 5,989 6,597 6,757 Other current liabilities 195 248 476 379 276 284 284 284 Total current liabilities 4,001 4,326 9,125 11,097 8,317 8,548 9,174 9,314 Long term debt 0 649 789 1,941 2,428 3,619 3,649 3,616 Other liabilities 86 91 128 133 190 287 287 287 Total LT liabilities 86 740 917 2,074 2,618 3,906 3,936 3,903 Total liabilities 4,088 5,066 10,042 13,171 10,935 12,454 13,110 13,217

Common stocks 9,138 11,307 14,189 17,551 18,934 19,090 20,564 22,148 Minority equity 54 47 26 0 0 0 0 0 Total equity 9,192 11,354 14,215 17,551 18,934 19,090 20,564 22,148 Total liabilities and equity 13,279 16,420 24,257 30,722 29,869 31,543 33,674 35,366 Source: Company data, Macquarie Research, November 2019

Fig 42 Cashflow Rmb m 2014 2015 2016 2017 2018 2019E 2020E 2021E

Profit before tax 2,581 3,435 4,633 5,996 4,310 2,269 3,109 3,635 Depreciation 511 698 953 1,295 1,714 2,007 2,006 2,005 Amortization 14 13 10 11 36 0 0 0 Change in net working capital -940 -282 -294 1,383 1,137 -332 -522 -120 Other adjustments -198 -105 -489 -3,398 -408 -146 -342 -400 Total operating cash flow 1,967 3,760 4,812 5,287 6,789 4,055 4,597 5,420

Capex -2,152 -2,344 -3,926 -4,814 -2,941 -2,000 -2,000 -2,000 Acquisition -20 -79 -29 -63 -155 0 0 0 (Purchase) Sale of ST investment -73 -82 -118 5 737 43 0 0 (Purchase) Sale of LT investment 46 7 1 -91 547 0 0 0 Others 45 29 -45 -45 -1,788 117 0 0 Total investment cash flow -2,153 -2,469 -4,117 -5,009 -3,599 -1,840 -2,000 -2,000

Increase (decrease) in debt 507 300 2,201 2,362 -555 -48 49 -53 Cash dividends -1,052 -940 -1,314 -1,662 -2,182 -1,518 -1,293 -1,651 Change in share capital 0 0 0 -513 -278 -277 0 0 Others -23 -82 -90 -201 -232 -154 0 0 Total financing cash flow -569 -721 797 -14 -3,247 -1,997 -1,244 -1,704

Net cash flow -755 570 1,491 264 -57 217 1,353 1,716 FX change 3 51 149 -95 81 0 0 0 Net cash flow after FX change -752 621 1,641 170 25 218 1,353 1,716

Free cashflow (OCF - CAPEX) -185 1,416 886 473 3,848 2,055 2,597 3,420 Source: Company data, Macquarie Research, November 2019

5 November 2019 110 Macquarie Research Global smartphones

The quant model currently holds a strong negative view on AAC Attractive Displays where the Technologies. The strongest style exposure is Quality, indicating this stock is company’s ranked based on likely to have a superior and more stable underlying earnings stream. The s

l the fundamental consensus a weakest style exposure is Growth, indicating this stock has weak historic t

n Price Target and and/or forecast growth. Growth metrics focus on both top and bottom line e

Macquarie’s Quantitative m

items. a

Alpha model.

d n

858/936 u Two rankings: Local market F (Hong Kong) and Global Global rank in sector (Technology Technology Hardware & Equipment Quant Hardware & Equipment) % of BUY recommendations 31% (9/29) Local market rank Global sector rank Number of Price Target downgrades 0 Number of Price Target upgrades 3

Luxshare (A-Share) 0.4 Luxshare (A-Share)

Merry Electronics 0.0 Merry Electronics

BYD Electronic -0.1 BYD Electronic

Sunny Optical -0.4 Sunny Optical

GoerTek (A-Share) -0.9 GoerTek (A-Share)

AAC Technologies -1.3 AAC Technologies

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Valuations Growth Profitability Earnings Price Quality Momentum Momentum

Luxshare (A-Share) Luxshare (A-Share) 0.3 Merry Electronics Merry Electronics -0.3 BYD Electronic BYD Electronic -0.5 Sunny Optical Sunny Optical 0.5 GoerTek (A-Share) GoerTek (A-Share) 0.7

AAC Technologies -0.7 AAC Technologies

-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 -100% -50% 0% 50% 100% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return

What drove this Company in the last 5 years How it looks on the Alpha model Which factor score has had the greatest correlation with the company’s A more granular view of the underlying style scores that drive the alpha (higher is returns over the last 5 years. better) and the percentile rank relative to the sector and market. ⇐ Negatives Positives ⇒ Normalized Percentile relative Percentile relative 3M Price Target Revisions… 33% Score to sector(/936) to market(/534) Alpha Model Score -1.26 Earnings Certainty 29% Valuation -0.22 Sales Revisions 3 Month 29% Growth -0.85 Number of Shares Increase… 28% Profitability 0.16 Earnings Momentum -0.53 Profit Margin NTM -24% Price Momentum -0.74 Turnover(USD) 125 Day -24% Quality 0.42 Capital & Funding 0.17 Volatility 250 Day -25% Liquidity -1.20 Turnover (USD) 250 Day -26% Risk -0.92 Technicals & Trading -0.40 -40% -20% 0% 20% 40% 0 50 100 0 50 100 0 0 1 1

5 November 2019 111 Macquarie Research Global smartphones

AAC Technologies (2018 HK) Interim Results 1H/19A 2H/19E 1H/20E 2H/20E Profit & Loss 2018A 2019E 2020E 2021E

Revenue m 7,568 10,078 8,949 11,262 Revenue m 18,131 17,645 20,210 21,837 Gross Profit m 2,084 2,917 2,613 3,519 Gross Profit m 6,743 5,001 6,132 6,675 Cost of Goods Sold m 5,483 7,161 6,335 7,742 Cost of Goods Sold m 11,388 12,644 14,078 15,162 EBITDA m 1,881 2,615 2,451 3,014 EBITDA m 6,014 4,496 5,465 5,936 Depreciation m 1,019 1,224 1,182 1,169 Depreciation m 1,714 2,243 2,352 2,304 Amortisation of Goodwill m 21 0 0 0 Amortisation of Goodwill m 36 21 0 0 Other Amortisation m 0 0 0 0 Other Amortisation m 0 0 0 0 EBIT m 841 1,390 1,269 1,845 EBIT m 4,265 2,232 3,113 3,632 Net Interest Income m -114 -114 -114 -113 Net Interest Income m -218 -228 -227 -228 Associates m 0 0 0 0 Associates m 0 0 0 0 Exceptionals m 0 0 0 0 Exceptionals m 0 0 0 0 Forex Gains / Losses m 30 0 0 0 Forex Gains / Losses m -2 30 0 0 Other Pre-Tax Income m 131 104 107 116 Other Pre-Tax Income m 266 235 223 231 Pre-Tax Profit m 888 1,381 1,261 1,848 Pre-Tax Profit m 4,310 2,269 3,109 3,635 Tax Expense m -118 -152 -139 -203 Tax Expense m -514 -270 -342 -400 Net Profit m 770 1,229 1,123 1,645 Net Profit m 3,796 1,999 2,767 3,235 Minority Interests m 0 0 0 0 Minority Interests m 0 0 0 0

Reported Earnings m 770 1,229 1,123 1,645 Reported Earnings m 3,796 1,999 2,767 3,235 Adjusted Earnings m 791 1,229 1,123 1,645 Adjusted Earnings m 3,832 2,020 2,767 3,235

EPS (rep) 0.64 1.02 0.93 1.36 EPS (rep) 3.11 1.65 2.29 2.68 EPS (adj) 0.65 1.02 0.93 1.36 EPS (adj) 3.14 1.67 2.29 2.68 EPS Growth yoy (adj) % -55.4 -39.0 42.0 33.8 EPS Growth (adj) % -28.2 -46.7 37.0 16.9 PE (rep) x 14.9 28.0 20.2 17.3 PE (adj) x 14.7 27.7 20.2 17.3

EBITDA Margin % 24.9 25.9 27.4 26.8 Total DPS 1.24 0.84 1.11 1.29 EBIT Margin % 11.1 13.8 14.2 16.4 Total Div Yield % 2.7 1.8 2.4 2.8 Earnings Split % 39.2 60.8 40.6 59.4 Basic Shares Outstanding m 1,221 1,209 1,209 1,209 Revenue Growth % -10.2 3.8 18.2 11.7 Diluted Shares Outstanding m 1,222 1,209 1,209 1,209 EBIT Growth % -57.0 -39.8 50.7 32.7

Profit and Loss Ratios 2018A 2019E 2020E 2021E Cashflow Analysis 2018A 2019E 2020E 2021E

Revenue Growth % -14.1 -2.7 14.5 8.1 EBITDA m 6,014 4,496 5,465 5,936 EBITDA Growth % -18.6 -25.2 21.5 8.6 Tax Paid m -514 -270 -342 -400 EBIT Growth % -29.9 -47.7 39.5 16.7 Chgs in Working Cap m 938 -332 -522 -120 Gross Profit Margin % 37.2 28.3 30.3 30.6 Net Interest Paid m -218 -228 -227 -228 EBITDA Margin % 33.2 25.5 27.0 27.2 Other m 569 389 223 231 EBIT Margin % 23.5 12.6 15.4 16.6 Operating Cashflow m 6,789 4,055 4,597 5,420 Net Profit Margin % 21.1 11.4 13.7 14.8 Acquisitions m -155 0 0 0 Payout Ratio % 39.6 50.4 48.3 48.3 Capex m -2,941 -2,000 -2,000 -2,000 EV/EBITDA x 9.9 13.1 10.7 9.9 Asset Sales m 0 0 0 0 EV/EBIT x 13.9 26.3 18.9 16.2 Other m -503 160 0 0 Investing Cashflow m -3,599 -1,840 -2,000 -2,000 Balance Sheet Ratios Dividend (Ordinary) m -2,182 -1,518 -1,293 -1,651 ROE % 21.0 10.6 14.0 15.1 Equity Raised m -0 -1 0 0 ROA % 14.1 7.3 9.5 10.5 Debt Movements m -555 -48 49 -53 ROIC % 19.0 9.5 13.4 15.5 Other m -510 -430 0 0 Net Debt/Equity % 9.5 8.3 1.4 -6.7 Financing Cashflow m -3,247 -1,997 -1,244 -1,704 Interest Cover x 19.6 9.8 13.7 15.9 Price/Book x 3.0 2.9 2.7 2.5 Net Chg in Cash/Debt m 92 181 1,353 1,716 Book Value per Share 15.5 15.8 17.0 18.3 Free Cashflow m 3,848 2,055 2,597 3,420

Balance Sheet 2018A 2019E 2020E 2021E

Cash m 4,126 4,308 5,661 7,377 Receivables m 4,474 5,196 5,882 6,045 Inventories m 3,319 4,371 4,814 4,931 Investments m 227 234 234 234 Fixed Assets m 15,440 16,888 16,536 16,232 Intangibles m 164 164 164 164 Other Assets m 2,117 382 382 382 Total Assets m 29,869 31,543 33,674 35,366 Payables m 4,548 5,989 6,597 6,757 Short Term Debt m 3,493 2,275 2,294 2,273 Long Term Debt m 2,428 3,619 3,649 3,616 Provisions m 0 0 0 0 Other Liabilities m 466 571 571 571 Total Liabilities m 10,935 12,454 13,110 13,217 Shareholders' Funds m 18,934 19,090 20,564 22,148 Minority Interests m 0 0 0 0 Other m 0 0 0 0 Total S/H Equity m 18,934 19,090 20,564 22,148 Total Liab & S/H Funds m 29,869 31,543 33,674 35,366

All figures in Rmb unless noted. Source: Company data, Macquarie Research, November 2019

5 November 2019 112 Macquarie Research Global smartphones

Important disclosures: Recommendation definitions Volatility index definition* Financial definitions Macquarie – Asia, USA, Europe and Mazi Macquarie This is calculated from the volatility of historical All "Adjusted" data items have had the following (SA): price movements. adjustments made: Outperform – expected return >10% Added back: goodwill amortisation, provision for Neutral – expected return from -10% to +10% Very high–highest risk – Stock should be catastrophe reserves, IFRS derivatives & hedging, Underperform – expected return <-10% expected to move up or down 60–100% in a year IFRS impairments & IFRS interest expense – investors should be aware this stock is highly Excluded: non recurring items, asset revals, property Macquarie - Australia/New Zealand speculative. revals, appraisal value uplift, preference dividends & Outperform – expected return >10% minority interests Neutral – expected return from 0% to 10% High – stock should be expected to move up or Underperform – expected return <0% down at least 40–60% in a year – investors should EPS = adjusted net profit / efpowa* be aware this stock could be speculative. ROA = adjusted ebit / average total assets Note: expected return is reflective of a Medium Volatility ROA Banks/Insurance = adjusted net profit /average stock and should be assumed to adjust proportionately Medium – stock should be expected to move up total assets with volatility risk or down at least 30–40% in a year. ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation Low–medium – stock should be expected to *equivalent fully paid ordinary weighted average move up or down at least 25–30% in a year. number of shares

Low – stock should be expected to move up or All Reported numbers for Australian/NZ listed stocks down at least 15–25% in a year. are modelled under IFRS (International Financial * Applicable to select stocks in Asia/Australia/NZ Reporting Standards).

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Recommendation proportions – For quarter ending 30 September 2019 AU/NZ Asia RSA USA EUR Outperform 43.12% 58.72% 48.53% 52.06% 54.02% (for global coverage by Macquarie, 3.09% of stocks followed are investment banking clients) Neutral 39.49% 28.86% 41.18% 44.19% 37.50% (for global coverage by Macquarie, 3.35% of stocks followed are investment banking clients) Underperform 17.39% 12.42% 10.29% 3.75% 8.48% (for global coverage by Macquarie, 3.08% of stocks followed are investment banking clients)

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5 November 2019 114

Equities

Asia Research Head of Equity Research Emerging Leaders Technology Jake Lynch (Asia – Head) (852) 3922 3583 Corinne Jian (Asia) (8862) 2734 7522 Nicolas Baratte (Asia) (852) 3922 5801 Hiroyuki Sakaida (Japan – Head) (813) 3512 6695 Kwang Cho (Korea) (822) 3705 4953 Damian Thong (Asia) (813) 3512 7877 Conrad Werner (ASEAN – Head) (65) 6601 0182 Conrad Werner (ASEAN) (65) 6601 0182 Jeffrey Ohlweiler (Greater China) (8862) 2734 7512 Bo Denworalak (Thailand) (662) 694 7774 Patrick Liao (Greater China) (8862) 2734 7515 Automobiles, Auto Parts Cherry Ma (Greater China) (852) 3922 5800 Infrastructure, Industrials, Transportation Janet Lewis (China, Japan) (813) 3512 7856 Erica Chen (Greater China) (8621) 2412 9024 Allen Yuan (China) (8621) 2412 9009 Patrick Dai (China) (8621) 2412 9082 Kaylin Tsai (Greater China) (8862) 2734 7523 James Hong (Korea) (822) 3705 8661 Eric Zong (China, Hong Kong) (852) 3922 4749 Hiroshi Taguchi (Japan) (813) 3512 7867 Amit Mishra (India) (9122) 6720 4084 Kunio Sakaida (Japan) (813) 3512 7873 Daniel Kim (Korea) (822) 3705 8641 Robert Pranata (Indonesia) (6221) 2598 8366 James Hong (Korea) (822) 3705 8661 Abhishek Bhandari (India) (9122) 6720 4088 Corinne Jian (Taiwan) (8862) 2734 7522 Banks and Financials Telecoms Inderjeetsingh Bhatia (India) (9122) 6720 4087 Nicolas Baratte (Asia) (852) 3922 5801 Scott Russell (Asia) (852) 3922 3567 Internet, Media and Software Dexter Hsu (China, Taiwan) (8862) 2734 7530 Andy Kim (Korea) (822) 3705 8690 Keisuke Moriyama (Japan) (813) 3512 7476 John Wang (China, Hong Kong) (852) 3922 3578 Prem Jearajasingam (ASEAN) (603) 2059 8989 Suresh Ganapathy (India) (9122) 6720 4078 Frank Chen (China, Hong Kong) (852) 3922 1433 Robert Pranata (Indonesia) (6221) 2598 8366 Nishant Shah (India) (9122) 6720 4099 Ellie Jiang (China, Hong Kong) (852) 3922 4110 Kervin Sisayan (Philippines) (632) 857 0893 Conrad Werner (Singapore) (65) 6601 0182 Andy Kim (Korea) (822) 3705 8690 Utilities, Renewables Jayden Vantarakis (Indonesia) (6221) 2598 8310 Alankar Garude (India) (9122) 6720 4134 Ben Shane Lim (Malaysia) (603) 2059 8868 Hiroyuki Sakaida (Japan) (813) 3512 6695 Oil, Gas and Petrochemicals Gilbert Lopez (Philippines) (632) 857 0892 Patrick Dai (China) (8621) 2412 9082 Peach Patharavanakul (Thailand) (662) 694 7753 Aditya Suresh (Asia) (852) 3922 1265 Sean Hu (China, Hong Kong) (852) 3922 3571 Kerry Cheng (China) (8621) 2412 9025 Basic Materials, Commodities Anna Park (Asia) (822) 3705 8669 Yasuhiro Nakada (Japan) (813) 3512 7862 Inderjeetsingh Bhatia (India) (9122) 6720 4087 David Ching (China, Hong Kong) (852) 3922 1823 Corinne Jian (Taiwan) (8862) 2734 7522 Karisa Magpayo (Philippines) (632) 857 0899 Harunobu Goroh (Japan) (813) 3512 7886 Ben Shane Lim (Malaysia) (603) 2059 8868 Strategy, Country Yasuhiro Nakada (Japan) (813) 3512 7862 Yupapan Polpornprasert (Thailand) (662) 694 7729 Anna Park (Korea) (822) 3705 8669 Viktor Shvets (Asia, Global) (852) 3922 3883 Pharmaceuticals and Healthcare Jayden Vantarakis (Indonesia) (6221) 2598 8310 David Ng (China, Hong Kong) (852) 3922 1291 Hiroyuki Sakaida (Japan) (813) 3512 6695 Conglomerates David Ng (China, Hong Kong) (852) 3922 1291 Xiang Gao (China, Hong Kong) (8621) 2412 9006 Daniel Kim (Korea) (822) 3705 8641 David Ng (China, Hong Kong) (852) 3922 1291 Corinne Jian (China) (8862) 2734 7522 Jeffrey Ohlweiler (Taiwan) (8862) 2734 7512 Gilbert Lopez (Philippines) (632) 857 0892 Mi Hyun Kim (Korea) (822) 3705 8689 Inderjeetsingh Bhatia (India) (9122) 6720 4087 Conrad Werner (Singapore) (65) 6601 0182 Alankar Garude (India) (9122) 6720 4134 Conrad Werner (ASEAN, Singapore) (65) 6601 0182 Jayden Vantarakis (Indonesia) (6221) 2598 8310 Consumer, Gaming Property, REIT Prem Jearajasingam (Malaysia) (603) 2059 8989 Linda Huang (Asia) (852) 3922 4068 David Ng (China, Hong Kong) (852) 3922 1291 Gilbert Lopez (Philippines) (632) 857 0892 Terence Chang (China, Hong Kong) (852) 3922 3581 Kelvin Tam (China) (852) 3922 1181 Peach Patharavanakul (Thailand) (662) 694 7753 Sunny Chow (China, Hong Kong) (852) 3922 3768 Nicholas Ting (Hong Kong) (852) 3922 1398 Edward Engel (China, Hong Kong) (852) 3922 5750 Keisuke Moriyama (Japan) (813) 3512 7476 Find our research at Leon Rapp (Japan) (813) 3512 7879 Derrick Heng (Singapore) (65) 6601 0436 Macquarie: www.macquarieinsights.com Kwang Cho (Korea) (822) 3705 4953 Abhishek Bhandari (India) (9122) 6720 4088 Refinitiv: www.refinitiv.com Amit Sinha (India) (9122) 6720 4085 Richard Danusaputra (Indonesia) (6221) 2598 8368 Bloomberg: MAC GO Factset: http://www.factset.com/home.aspx Robert Pranata (Indonesia) (6221) 2598 8366 Aiman Mohamad (Malaysia) (603) 2059 8986 CapitalIQ www.capitaliq.com Denise Soon (Malaysia) (603) 2059 8845 Kervin Sisayan (Philippines) (632) 857 0893 Contact [email protected] for access Karisa Magpayo (Philippines) (632) 857 0899 Bo Denworalak (Thailand) (662) 694 7774 requests. Chalinee Congmuang (Thailand) (662) 694 7993

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