EQUITY RESEARCH REPORT TELECOMS, MEDIA & TECHNOLOGY September 2018
By: Frank He (S1700517120005) https://www.research.hsbc.com
China Semiconductors Narrowing the gap – China’s great chip challenge
China’s semiconductor industry is making rapid advances but still falls far short of meeting domestic demand
We identify investment opportunities in areas where the technology gap with foreign rivals is narrowing
We initiate coverage on the A-share semiconductor supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold)
Play interview with Frank He
Disclaimer & Disclosures: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it 加入智库微信群，每日免费获取报告
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Why read this report?
China’s high-tech economy needs far more home-grown chips – we explain where they will come from
We identify which A-share companies stand to benefit most from this move up the technology ladder
We initiate coverage on four major players in China’s semiconductor supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold)
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Contents
Narrowing the gap 3
The rise of China’s IC makers 11
Three opportunities 20
Company updates 44 Naura (002371 CH) 45 Han’s Laser (002008 CH) 59 Tongfu Microelectronics (002156 CH) 72 GigaDevice (603986 CH) 83
Disclosure appendix 98
Disclaimer 101
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Narrowing the gap
As in so many other industries, the market for semiconductors in China is the biggest in the world. The problem is that only a fraction are made by domestic companies, creating a technology gap that is too wide for comfort. This report looks at how China plans to close the gap and identifies the most promising A-share investments linked to this theme. We initiate coverage on Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold).
Few can dispute that China’s tech industry is now a force to be reckoned with. In areas such as mobile payments, e-commerce and telecom equipment, Chinese companies are already the envy of the world. Elsewhere, however, a great deal of work remains to be done.
Nowhere is this more apparent than in the realm of semiconductors, the integrated circuits used in everything from telecom equipment and personal computers to giant servers and applications for artificial intelligence and robotics. One stat helps to tell the story – while China is the world’s biggest chip market, an industry estimate suggests that only 13% of the semiconductors required by the country’s tech industry were manufactured by domestic companies last year (this figure rises to 42% if the output by foreign companies in China is included).
This reliance on products imported from other countries is a concern for China’s government. It This reliance on products imported from other has made technological independence a policy priority, especially now that trade tensions with countries is a concern the US are rising. China has no desire to remain the world’s No 1 assembler of electronics. It wants to be at the forefront of designing and manufacturing the semiconductors that will drive its new, high-tech and smarter economy in the age of artificial intelligence, 5G telecom, the Internet of Things (IoT), and autonomous driving. In this report we:
Identify investment opportunities in areas where we believe Chinese companies have competitive advantages or can gain market share, such as the design of integrated circuits (ICs), semiconductor equipment, and IC packaging and testing.
Assess the drivers that will help to close the technology gap, including huge investments in capital expenditure and R&D, as well as supportive government policy.
Look at the obstacles that stand in China’s way, such as restrictions on imports, the difficulty of making overseas acquisitions, and limited domestic supply of key materials in the semiconductor supply chain.
Initiate coverage on four A-share companies in that supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy) and GigaDevice (Hold).
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Investment opportunities
China has been looking to accelerate the development its domestic semiconductor market for The recent trade tensions with the US have underlined several years. According the roadmap outlined in the high-profile “Made in China 2025” the importance of this policy industrial development policy, China’s self-sufficiency in integrated circuits will increase to 49% in 2020 and 75% in 2030, including production by foreign companies. The recent trade tensions with the US have underlined the importance of this policy. For example, the ban on US sales to domestic telecom equipment manufacturer ZTE Corp – since lifted – highlighted the dependence of Chinese companies on imported chips.
It’s a huge market. China is the biggest consumer and importer of semiconductors, accounting for USD193bn of USD343bn of global sales of integrated circuits last year. China produced 1.9bn smartphones, 307m PCs and 172m TVs in 2017, accounting for over 90%, 70% and 80% of global supply, respectively. At the same time, we estimate that Huawei and ZTE share over 50% of the global telecom equipment market. So, given current trade relations with the US, the need for technological independence has never been greater.
As usual in China, growth has been remarkable. According to data from PWC, China’s semiconductor consumption growth exceeded worldwide growth for the sixth consecutive year in 2016. Domestic semiconductor consumption grew 2.9% in 2016 to reach record 60.6% of the global market, while the worldwide semiconductor market only grew 1.1%. During the past 10 years, semiconductor consumption in China has grown at CAGR of 12%, far ahead of the global rate of 3.2%.
And, as always in China, policy support is a major factor. To accelerate efforts to gain As always in China, policy support is a major factor self-sufficiency in semiconductors, in 2014 the government set up the China National Integrated Circuit Industry Investment Fund. According the Ministry of Industry and Information Technology (MIIT), the goal is to invest in chip manufacturing, boost industrial production and research, and promote mergers and acquisitions.
The fund operates as a corporate entity under the MIIT and the Ministry of Finance. Commonly referred to as the “Big Fund”, it has previously backed major projects including a Tsinghua Unigroup memory chip plant worth USD24bn that is under construction in the city of Wuhan (source: Reuters, 25 April 2018). A second fund is being put together to provide further support for the sector.
In another policy move, China’s finance ministry has introduced tax breaks for domestic chipmakers (Reuters, 30 March 2018). Chipmakers will be exempt from corporate taxes for two to five years followed by partial deductions. The exemptions cover a range of products, from very basic to cutting-edge chips, for use in computers, smartphones and other electronic devices.
We think that all these developments create opportunities for investors, especially in areas where we believe Chinese companies have a competitive edge or are well positioned to gain market share. They include:
IC design Ten Chinese companies were ranked in the world’s top 50 IC design companies last year, up from one in 2009. Their market share has increased from 5% in 2010 to 11% in 2017. Chinese companies have a particularly strong presence in application-specific integrated circuit (ASIC) based artificial intelligence (AI) and blockchain as well as the NOR flash memory segment. The addressable market size of ASIC-based AI chips will surge from USD1bn in 2017 to USD4.6bn in 2020, according to Frost & Sullivan, and account for 30% of the total chip market in 2020, up from 19% in 2017. We see a balanced demand and supply outlook for NOR flash in 2018-19, which would favour leading suppliers such as GigaDevice.
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Equipment China’s spending on fab equipment is set to increase by 57% y-o-y in 2018 and 60% in 2019 according to SEMI, a provider of data on the electronics supply chain. This means China is likely to overtake Korea, the world’s biggest spender in this area, in 2019. Since May last year Chinese companies have been able to mass produce over 16 kinds of front-end wafer fabrication equipment (mainly covering 28nm and above). The issue here is that their aggregate market share in equipment installation in Chinese foundries is still only 5%. The big gap between the high capex cycle and the low self-sufficiency ratio creates ample opportunities for domestic semi equipment makers. We believe Naura will be the major beneficiary in this localization trend in wafer fabrication.
Packaging and testing IC packaging and testing is the sector where the technology gap between Chinese companies IC packaging and testing is the sector where the technology and global rivals is the smallest. Industry consolidation via M&A has increased the competitive gap is the smallest strength of Chinese vendors in the past three years. Among the global top 10 outsourced assembly and test (OSAT) companies the revenue contribution from China’s three leaders – JECT, Huatian, Tongfu – has increased from 6.6% in 2011 to 21.2% in 2017, driven by organic growth and acquisition. We think a shift in industry drivers from smartphones to automobiles and the Internet of Things (IoT) will change the competitive landscape. We like Tongfu due to its strategic acquisition of two packaging and test fabs owned by Advanced Micro Devices (AMD), a US company, and its customer base that includes NXP, MediaTek, Texas Instruments, Infineon, and STMicro.
Exhibit 1. China IC supply chain EDA Fabless design Foundry OSAT Equipment Material software ICScape HiSilicon Allwinner SMIC JCET Naura Shanghai Sinyang Tech GigaDevice Goke Micro Huahong Huatian AMEC Ningbo Konfoong
Spreadtrum Ingenic Huali Tongfu Zhejiang JingSheng Kumpur
RDA Fullhan WLCSP Han's Laser Suzhou Ruihong
Goodix Bitmain SJ Semi ACM Research Guoxin Micro Cambricon Universal Shanghai Micro Scientific Electornics Will Semi Canaan Piotech Hangzhou Silan Microelectronics Yangtze Memory/Wuhan XMC Hefei Changxin Fujian Jinhua Note: listed companies are highlighted red Source: Company data, HSBC Qianhai Securities
Stock initiations
Naura (002371 CH, Buy) Naura Technology is a leading advanced electronic equipment and precision component maker, with products covering the semiconductor, LED, photovoltaic, display, and aerospace industries. It is China’s largest semiconductor equipment company in terms of revenue, with a comprehensive product portfolio covering etcher, physical vapor deposition (PVD), chemical vapor deposition (CVD), oxidation, and cleaning. Its customers include SMIC, Huali Microelectronics, San’An, HC SemiTek, BOE, and Longi Silicon. The company provides 28nm and above and is in the R&D stage for 14nm. We forecast Naura to achieve a 52% net profit CAGR over 2017-20e. Catalysts include design wins from foundry customers, R&D breakthroughs in 28nm, plus IC equipment. We initiate coverage with a Buy rating and a target price of RMB63.97, based on one standard deviation above the mid-cycle price to sales (P/S) ratio of 8.4x.
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Han’s Laser (002008 CH, Buy) Han’s Laser is a leading laser and automation equipment and system provider. It supplies products for laser labeling/cutting/welding equipment for consumer electronics and industrial applications, PCB/LED/semiconductor special equipment, robots, automation equipment and system solutions. We believe a recovery in orders for Apple in 2019, structural growth in high power lasers and wider laser applications, and growing vertical integration will enable the company to achieve a 29% net profit CAGR over 2017-20e. Moreover, we think the strategic move into semiconductor equipment through the acquisition of US company Fortrend will be a new growth driver. Catalysts include order wins in high power and semiconductor equipment, as well as the self development of high power laser generators. We initiate coverage with a Buy rating and a target price of RMB50.59, based on 22x mid-cycle PE.
Tongfu Microelectronics (002156 CH, Buy) Tongfu is the third largest packaging & testing company in China. The company is enhancing its competitiveness via the acquisition of an 85% stake in AMD’s packaging and testing fabs in Suzhou and Penang in 2016 (in collaboration with China’s national IC fund). Tongfu now captures over 80% of AMD’s total packaging & testing business and AMD accounted for 45% of total revenue in 2017. The company is set to benefit from AMD’s potential market share gains in PC, server CPU, and graphic cards in the coming years. Meanwhile, new orders from Bitmain and Broadcom in 2018-19 and its high exposure to auto IC customers also serve as a long-term driver. We forecast a 44% net profit CAGR in 2018-20e, which is slightly higher than the A- share sector average CAGR of 37%. Catalysts include new customer acquisitions, improved product mix, and breakthroughs in advanced packaging. We initiate coverage with a Buy rating and a target price of RMB12.05, based on 35x (A-share semiconductor sector average) forward PE.
GigaDevice (603986 CH, Hold) GigaDevice is China’s primary memory IC design house, with strong exposure to NAND flash, Key customers include Spreadtrum, RDA, MediaTek microcontrollers (MCU), and NOR flash. It had a 13% global market share in NOR flash in 2017. and Samsung Its key customers include Spreadtrum, RDA, MediaTek and Samsung. Leveraging its close relationship with SMIC, we believe the company will continue to gain market share in low- density NOR flash while seeking opportunities in advanced NOR flash and SLC NAND flash markets. Moreover, its strategic partnership with the Hefei city government in Anhui Province to develop 19nm DDR4 DRAM should be a long-term growth driver. We forecast the company will register a 37% net profit CAGR over 2017-20e; catalysts include R&D progress in DRAM and NAND flash. We initiate coverage with a Hold rating and a target price of RMB107.19, based on 45.3x historical average forward PE.
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Exhibit 2. 2017 revenue breakdown for covered semiconductor stocks
Product Naura Han's Laser GigaDevice Tongfu NOR flash 85% IC Design NAND 0% MCU 14% Packaging 99% & testing IC/Semiconductor 18% 2% LED 23% 5% Solar 14% Equipment Display 6% Lithium battery 4% PCB 10% Laser 81% Component 34% Others 1% 2% 0% 1% Total 100% 100% 100% 100%
Source: Company data, HSBC Qianhai Securities
Exhibit 3. Valuation summary table Company HSBC Market cap ADVT EPS CAGR Ticker Name Rating USDm USDm CP TP Upside Valuation methodology 2017-20e 002371 CH Naura Buy 3,257 142 53.26 63.97 20% 12m forward PS of 8.4x, +1 std above mid-cycle 52% 002008 CH Han’s Laser Buy 6,427 129 42.77 50.59 18% 12m forward PE of 22x, mid-cycle 29% 002156 CH Tongfu Buy 1,716 22 10.05 12.05 20% 12m forward PE of 35x, A-share sector average multiple 74% 603986 CH GigaDevice Hold 4,514 119 110.00 107.19 -3% 12m forward PE of 45.3x, mid-cycle 37% Source: Company data, HSBC Qianhai Securities. Note: share prices as at close of 3 Sep 2018.
Where we are different from consensus
Our earnings estimates for 2019-20e for Han’s Laser and Tongfu are generally in-line or higher than Bloomberg consensus. We are more optimistic on Han’s Laser‘s long-term growth potential of sales in high power lasers, semiconductors, and OLED equipment sales. We also see revenue upside for Tongfu as it switches AMD’s two in-house fabs to OSATs, as well as order wins from domestic customers in the long term.
Our estimates for GigaDevice and Naura are much lower than market expectations. For GigaDevice, we model a flattish pricing trend for NOR flash as the company focuses on low- density product categories which are not facing supply shortages. Our 2018 revenue and profit estimates for Naura are in line with company guidance. For 2019-20, we remain positive on the sales growth of IC equipment – its core business – but are cautious on solar and LED equipment revenue.
Exhibit 4. Our EPS growth forecasts vs consensus HSBC ______HSBC Qianhai ______Consensus ______HSBC vs Consensus _____ Company Stock code CP RMB rating TP RMB 2018e 2019e 2020e 2018e 2019e 2020e 2018e 2019e 2020e Naura 002371 CH 53.26 Buy 63.97 0.37 0.62 0.97 0.53 0.81 1.12 -30% -24% -14% Han’s Laser 002008 CH 42.77 Buy 50.59 1.82 2.60 3.55 1.95 2.47 3.19 -6% 5% 5% Tongfu 002156 CH 10.05 Buy 12.05 0.27 0.40 0.55 0.29 0.40 0.51 -8% -1% 8% GigaDevice 603986 CH 110.00 Hold 107.19 1.93 2.69 3.63 2.27 3.12 4.21 -14% -12% -12% Source: Bloomberg, HSBC Qianhai Securities estimates (priced at close of 3 Sep 2018)
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Risk factors
Restrictions on component, equipment and IP imports from the US Friction between China and the US over trade and intellectual property have resulted in the US government imposing sanctions on certain Chinese technology companies. In April, US companies were banned from exporting products/services to ZTE; the ban was lifted after ZTE paid a USD1.4bn penalty. Then, in August, sanctions prohibited the export of products and technology to 44 Chinese technology companies and research institutes with exposure to the military and aviation.
Meanwhile, China’s regulator has still not approved Qualcomm’s proposed acquisition of NXP Semiconductors, a Dutch company with a high level of exposure to the China market. Any further escalation of trade tensions might lead to additional tightening measures on Chinese technology companies that rely on components, equipment and intellectual property (IP) imports from the US, as well as Chinese exports to the US.
Take IC equipment as an example. US companies such as Applied Materials and Lam Research have leading positions in making advanced IC equipment which Chinese companies are not able to produce domestically. Failure to procure IC equipment from US companies may lead to a significant slowdown in the development of China’s IC foundries. Here we summarise the risks and potential impact on our covered stocks:
Naura: The company doesn’t disclose details about its sourcing strategy but we believe it sources Exposure to US sales and some of its components/parts from overseas, including the US. Naura indicates that each component supply varies by company component/part normally has more than one supplier, which gives it some flexibility in terms of sourcing. Naura doesn’t have US export exposure as it mainly serves domestic customers.
Han’s Laser: Han’s sourced 80% of its high-power lasers from US supplier IPG Photonics for its high-power equipment segment in 2017, which accounted for 18% of total revenue last year. This year the company has started to build its own lasers, with power output of 1kw. IPG also has multiple manufacturing facilities around the world, including in the US, Germany, Russia and Italy, which could help to avoid any potential import duties and export controls. Han’s has minimal export sales to the US.
Tongfu: The company mainly sources packaging & testing equipment from Japan, Korea, Singapore and Europe, with minimal exposure to US. However, its largest customers include leading US IC fabless and IDMs, such as AMD, Broadcom, and Texas Instruments. We estimate sales to US customers represent over 50% of its total revenue.
GigaDevice: The company relies mainly on domestic foundry and OSAT in IC manufacturing and packaging, and its customers are mostly domestic OEMs, so exposure to the US is small.
More broadly speaking, leading semiconductor companies may become more aggressive in terms of defending their market share and industry positions in the light of technological advances being made by Chinese peers. For example, leading overseas IC equipment suppliers have traditionally charged premium prices for equipment that China is not able to produce. Once Chinese tech companies catch up, foreign suppliers may significantly lower their selling prices in order to squeeze the margins of domestic companies.
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Valuation and risks
Valuation Risks
Current price: We apply 12m forward P/S instead of PE to value Naura as: 1) Slower-than-expected development in advanced IC Naura RMB53.26 Naura’s earnings performance is volatile and largely depends on equipment 002371 CH Target price: government subsidies; 2) Naura is still at the early stage of Slower order inflow and customer concentration of solar
RMB63.97 attracting foundry customers and offers ample revenue growth equipment potential. We estimate a 52% earnings CAGR in 2017-20e, vs. 6% Uncertainty over government subsidies and income Buy Up/downside: in 2010-17. The stock is trading at 6.8x forward P/S, in line with its 20% mid-cycle average of 6.3x. In light of Naura’s faster revenue growth recognition outlook, we think it is reasonable to apply one standard deviation
above mid-cycle of 8.4x to set the target price, which equals RMB63.97, implying 20% upside. We initiate with a Buy rating. Frank He | [email protected] | +86 755 8898 3136
Current price: We apply a 12m forward PE to value Han’s Laser. We project a net Slower innovation progress by key customers Han’s Laser RMB42.77 profit CAGR of 29% over 2017-20e, in line with the 32% CAGR Slower laser source import substitution progress 002008 CH Target price: during 2008-17. We think it is reasonable to apply a mid-cycle average valuation of 22x for the stock, which translates into our Regulatory changes in component sourcing policy RMB50.59 target price of RMB50.59, implying 18% upside. With the growing
Buy Up/downside: diversification of its customer base and a solid earnings growth 18% outlook, we believe our target multiple valuation is justified. We
initiate with a Buy rating. Frank He | [email protected] | +86 755 8898 3136
Current price: We apply a 12m forward PE to value Tongfu. The shares have High revenue contribution from single client Tongfu RMB10.05 historically traded in quite a wide range, with an average mid-cycle 002156 CH High reliance on external sourcing of raw materials and key Target price: forward PE of 60x and one standard deviation of 33x, given its components
RMB12.05 cyclical earnings trend before 2015. But since the acquisition of AMD’s packaging and testing fabs in 2016, we believe Tongfu’s Market share loss in key customers
Buy Up/downside: revenue and earnings growth profile has structurally changed and Longer-than-expected new customer order wins 20% become less volatile and more predictable. Therefore, we apply the A-share semiconductor peer group’s valuation matrix to value the stock. We apply a 35x forward PE to Tongfu, in line with A-share
sector average multiple. Accordingly, we derive a 12m target price for Tongfu of RMB12.05, implying 20% upside. We initiate with a Buy rating. Frank He | [email protected] | +86 755 8898 3136
Current price: We apply a 12m forward PE to value GigaDevice, with reference to Upside GigaDevice RMB110.00 its historical valuation and earnings growth trend. We forecast a 603986 CH Design wins in high-density, high-quality NOR Flash Target price: 37% net profit CAGR in 2017-20e, similar to its historical CAGR of Higher revenue growth in SLC NAND Flash RMB107.19 44% during 2012-17. We believe it is reasonable to apply a historical average forward PE of 45.3x to value the stock. Downside Hold Up/downside: Accordingly, our 12m target price is RMB107.19, implying -3% Lower NOR flash pricing and margin -3% downside. We rate the stock as a Hold. Slower-than-expected DRAM project development
Frank He | [email protected] | +86 755 8898 3136
Priced at 3 Sep 2018 Source: HSBC estimates
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Exhibit 5. Comparable global semiconductor value chain Market cap DAV _ PE (x) __ PS (x) PB (x) EPS CAGR EV/EBITDA ROE (%) Div yield (%) Ticker Company Currency Price USDm USDm 18e 19e 18e 18e 18-20e 18e 18e 18e A-share 002371 CH NAURA TECH CNY 53.26 3,569 99 101.9 64.3 7.2 6.8 53% 51.4 7.1 0.2 002008 CH HAN'S LASER CNY 42.77 6,677 99 21.4 16.4 3.2 5.2 30% 18.5 25.0 1.0 002156 CH TONGFU MICRO CNY 10.05 1,696 13 30.0 19.9 1.4 1.8 39% 10.6 6.2 0.9 603986 CH GIGADEVICE SEMI CNY 110.00 4,566 86 49.5 34.3 10.2 14.5 45% 46.1 30.9 0.3 600584 CH JCET CNY 15.11 3,539 31 32.9 19.9 0.9 2.3 51% 9.4 7.1 0.3 300316 CH ZHEJIANG JINGSHENG CNY 12.46 2,357 34 23.0 17.9 5.0 3.9 25% 19.6 16.6 1.2 002049 CH UNIGROUP GUOXIN CNY 43.04 3,849 133 66.7 54.4 10.6 6.9 22% 41.8 11.1 0.2 300613 CH SHANGHAI FULLHAN CNY 119.85 801 7 40.4 28.0 8.9 5.0 37% 25.9 12.3 0.2 002185 CH TIANSHUI HUATIAN CNY 5.06 1,584 15 18.0 14.4 1.3 1.8 24% 8.3 10.1 0.9 600703 CH SANAN OPTOELECTRONICS CNY 15.94 9,458 95 16.4 12.8 6.0 2.8 27% 10.4 17.5 2.2 600460 CH HANGZHOU SILAN CNY 11.35 2,179 59 61.8 47.2 4.4 5.0 28% 33.2 8.6 0.8 300672 CH GOKE MICRO CNY 51.04 840 16 76.5 38.8 11.5 0.0 54% - 7.1 0.0 300666 CH KONFOONG MATERIALS CNY 47.00 1,518 36 124.2 85.5 13.6 16.0 38% 80.7 13.0 0.0 300458 CH ALL WINNER TECH CNY 23.67 1,153 21 49.2 35.2 5.1 3.6 38% 32.0 7.1 0.0 603005 CH CHINA WAFER LEVEL CSP CNY 20.23 692 6 37.2 24.7 5.9 2.5 44% 14.7 6.6 0.0 300323 CH HC SEMITEK CNY 11.60 1,872 12 15.9 11.6 3.0 2.4 33% 11.9 16.6 0.5 47.8 32.8 6.1 5.0 37% 27.6 12.7 0.5 Offshore 981 HK SMIC HKD 9.04 5,819 31 60.6 60.6 1.7 1.1 36% 9.0 1.6 0.0 1347 HK HUA HONG SEMI HKD 20.00 2,652 27 16.4 14.9 2.9 1.3 12% 8.3 8.9 1.7 522 HK ASM PACIFIC HKD 82.05 4,228 22 11.6 10.8 1.7 2.6 9% 8.0 24.0 3.6 SNPS US SYNOPSYS INC USD 102.14 15,177 108 26.1 24.2 4.9 4.8 10% 21.2 18.4 - CDNS US CADENCE DESIGN USD 47.04 13,303 65 27.9 25.6 6.4 10.1 9% 18.7 40.9 - INTC US INTEL CORP USD 48.43 223,311 1,211 11.7 11.4 3.2 3.0 3% 7.8 22.2 2.5 005930 KS SAMSUNG ELECTRON KRW 47650.00 274,320 340 6.7 6.6 1.2 1.3 3% 2.6 21.2 3.0 000660 KS SK HYNIX INC KRW 80900.00 52,819 262 3.5 3.7 1.4 1.2 -6% 1.9 39.9 2.0 MU US MICRON TECH USD 52.52 60,913 1,576 4.5 4.5 2.0 2.0 -6% 3.1 55.8 0.0 WDC US WESTERN DIGITAL USD 63.24 18,425 291 5.4 5.2 0.9 1.5 5% 4.0 27.6 3.2 TXN US TEXAS INSTRUMENT USD 112.40 109,275 493 19.6 18.1 6.8 10.4 8% 14.0 52.8 2.3 NXPI US NXP SEMICONDUCTO USD 93.14 32,040 917 13.6 11.8 3.4 2.5 19% 11.2 11.0 0.0 6502 JP TOSHIBA CORP JPY 332.00 19,483 47 1.8 12.5 0.6 1.2 -61% 6.6 88.8 0.8 IFNNY US INFINEON TEC-ADR USD 25.44 28,913 4 23.0 20.7 3.3 3.8 10% 10.9 17.9 1.3 STM FP STMICROELECTRONI EUR 17.72 18,725 48 15.3 13.7 1.9 3.0 9% 8.4 20.7 1.3 QCOM US QUALCOMM INC USD 68.71 100,943 816 19.0 16.3 4.5 5.3 20% 12.3 22.8 3.5 AVGO US BROADCOM INC USD 219.03 94,551 887 10.9 10.6 4.6 3.3 7% 9.2 33.5 3.2 2454 TT MEDIATEK TWD 253.50 13,024 52 18.0 14.2 1.7 1.5 24% 11.9 8.5 3.8 NVDA US NVIDIA CORP USD 280.68 170,653 2,855 35.2 31.7 13.1 15.6 14% 30.7 51.1 0.2 AMD US ADV MICRO DEVICE USD 25.17 24,538 2,169 55.4 39.8 3.7 25.3 40% 29.7 52.4 0.0 MRVL US MARVELL TECH GRP USD 20.68 13,519 146 15.0 14.0 5.4 2.2 7% 14.2 15.9 1.2 XLNX US XILINX INC USD 77.83 19,684 171 22.5 20.9 6.9 8.1 16% 19.3 31.9 1.9 2379 TT REALTEK SEMI TWD 144.50 2,389 17 19.0 16.5 1.6 3.2 14% 10.6 17.1 4.2 DLG GY DIALOG SEMICOND EUR 20.21 1,791 15 9.4 11.6 1.2 1.2 -18% 4.1 12.4 0.0 2330 TT TSMC TWD 256.50 216,382 207 18.7 16.6 6.4 4.0 13% 8.9 22.3 3.2 2303 TT UMC TWD 17.15 7,044 29 19.0 18.7 1.4 1.0 7% 3.8 5.2 4.3 3711 TT ASE TECHNOLOGY H TWD 73.80 10,370 17 14.5 12.6 0.8 1.6 20% 6.5 11.5 3.1 AMKR US AMKOR TECH INC USD 8.73 2,091 9 15.6 10.6 0.5 1.1 27% 3.6 7.8 - 6239 TT POWERTECH TWD 88.40 2,241 7 10.2 9.0 1.0 1.7 9% 4.1 15.6 5.8 AMAT US APPLIED MATERIAL USD 43.02 42,288 547 9.7 9.8 2.5 6.4 7% 8.2 53.6 1.4 ASML US ASML HOLDING-NY USD 205.05 88,472 157 30.4 25.1 7.2 6.4 24% 22.8 22.1 0.9 LRCX US LAM RESEARCH USD 173.09 27,276 498 10.9 9.4 2.6 3.9 17% 7.4 29.6 2.4 KLAC US KLA-TENCOR CORP USD 116.21 18,143 172 12.8 12.1 4.1 8.6 5% 9.6 78.1 2.6 Average 18.0 16.5 3.4 4.5 9% 10.7 28.6 2.1 Share prices as at 3 Sep 2018 Source: Company data, Wind, Bloomberg
10 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018
The rise of China’s IC makers
China is gradually climbing up the IC value chain and is likely to become a mainstream player in the coming decade Positive drivers include strong demand, a slowdown in Moore’s Law, fast-growing domestic investment, and government policy support We see opportunities in IC design, equipment and OSAT
The country needs to be more IC self-sufficient
China is the biggest consumer and importer of semiconductors, accounting for USD193bn of the USD343bn in global sales of integrated circuits last year. China produced 1.9bn smartphones, 307m PCs and 172m TVs in 2017, representing more than 90%, 70% and 80% of global supply, respectively. At the same time, we estimate that Huawei and ZTE share over 50% of the global telecom equipment market. So, given current trade relations with the US, the need for technological independence has never been greater.
Exhibit 6. China consumes over 50% of Exhibit 7. China’s IC demand by global IC supply application in 2016 400 70% (USDbn) 63.8% 65.1% Auto 350 59.3% 60.7% 56.4% 57.0% 60% electronics, Others, 4.4% 300 50.6% 3.9% 50% Network 250 communicati 40% Industrial, on, 30.6% 200 12.8% 30% 150 20% 100
50 10% Consumer 0 0% electronics, 2011 2012 2013 2014 2015 2016 2017 21.9% Computer, Global IC sales China IC demand China's market share in demand 26.4%
Source: Wind Source: CCID
China’s IC imports totalled USD260bn in 2017, up 15% y-o-y, and represented the country’s No. 1 category of imported goods, higher than crude oil, agricultural products, and iron ore. The value of domestic IC output was RMB541bn (USD80bn) in 2017 and if we include production by foreign companies in China we estimate the country’s IC self-sufficiency ratio was 42% in 2017, up from 24% in 2011. However, according to IC insights, a semiconductor research company, if products manufactured by foreign enterprises in China are excluded, the ratio falls to 13%.
According to the “Made in China 2025” policy roadmap, the self-sufficiency ratio will increase to 49% in 2020 and 75% in 2030, including foreign output in China. We estimate that China’s
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domestic IC sales/value output will grow from the current RMB541bn to RMB791bn in 2020 and RMB1,971bn in 2030, implying a 13% CAGR for 2017-20e and 10% over 2020-30e.
Exhibit 8. China’s major imported product Exhibit 9. China’s IC demand, supply and by value: IC is ranked top self-sufficiency projection 3,000 80% Import product category in 2017 (USDbn) (RMBbn) 75% Integrated circuits 260.1 70% 2,500 Crude oil 162.3 60% Agricultural product 124.7 2,000 49% 50% Iron ore and concentrates 76.3 41% 36% 1,500 33% 40% Auto 51.0 29% 25% 27% 30% Plastic 48.5 1,000 24% Copper and concentrates 26.4 20% 500 10%
- 0% 2011 2012 2013 2014 2015 2016 2017 2020e 2030e China IC demand China IC output Self-supply ratio
Source: Wind Source: China Semiconductor Industry Association, MIIT
Despite this rapid growth, shortages remain in processors/controllers and memory products, which accounted for 46% and 28% of total import value in 2016. Local suppliers can currently only provide mid-to-entry level microcontrollers and memory products such as NOR Flash, 2D NAND Flash and DDR3 DRAM.
Exhibit 10. China’s IC import and export Exhibit 11. China’s IC import by category trend in 2016 300 (USDbn) 260 (USDbn) 250 Others, 49 , 231 230 227 218 21% Processor and 193 200 192 controller, 105 , 46% 170 166 157 157 161 144 150 138 139 Amplifier, 10 , 129 128 120 5% 105 97 100 88 69 61 61 67 53 50 33 24 23 29 Memory, 64 , 28% 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Import Export Deficit
Source: Wind Source: Wind
Moving up the value chain China’s domestic IC sales increased from RMB193.4bn in 2011 to RMB541.1bn in 2017, implying a 19% CAGR. This is much faster than the 8% CAGR for China’s IC demand and 6% CAGR for global IC sales over the same period. The IC design and manufacturing segments are the key growth drivers, registering CAGRs of 26% and 22%, well ahead of packaging & testing (12%). The challenge is to move up the value chain.
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Exhibit 12. China IC sales/value output by Exhibit 13. China IC sales/output value y-o-y segment by segment vs. global IC sales trend 60% 600 (RMBbn) 50% 500 40% 189 30% 400
19% CAGR in 2005-17 156 20% 300 138 145 10% 126 113 0% 200 110 90 104 -10% 98 71 63 60 100 63 62 207 -20% 51 50 43 50 164 45 133 34 40 39 34 81 105 23 31 53 62 -30% 19 23 24 27 36 0 12 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 China total China design Design Manufacturing Packaging & testing China manufacturing China packaging & testing Global Source: Wind Source: Wind
As illustrated in Exhibit 14, Chinese IC companies can compete in categories such as smartphone application processors (AP), base band processors (CP) and network processor units (NPU), but generally have a weak presence in more advanced areas such as microprocessors (MPU), memory, field-programmable gate array (FPGA), and graphic processing units (GPU).
At the product level, the domestic companies can meet demand for most lower-end IC chips for surveillance cameras, set top boxes and home networks, radio frequency identification (RFID) solutions, identify cards, SIM cards, and bank card, which require simple functionality and limited computing power.
The technology gap with global rivals is clear, even in areas like the smartphone System on The technology gap with global rivals is clear Chip (SoC). Simply put, overseas companies have a far greater ability to customize components than their Chinese peers. Qualcomm, Apple, MediaTek, and HiSilicon all license ARM’s instruction set architecture (ISA) for building their own SoC. But they then customize different components – CPU, GPU, modem, storage, digital signal processor (DSP), image signal processor (ISP) – which helps to differentiate the features and performance of smartphones.
For example, Qualcomm’s Snapdragon 845 processor is based on 64-bit ARMv8-A architecture but has been customized to optimize the performance and power consumption of its CPU, GPU, and DSP. Apple’s A11 Bionic processor CPU also customizes ARM’s ISA and has developed its GPU in-house. However, Chinese companies struggle to compete in this area. In the case Huawei’s HiSilison’s Kirin 970, its CPU and GPU are also licensed from standard ARMv8-A (Coretex A73 and A53) architecture but there are no subsequent modifications.
However, we believe this creates opportunities for China to catch up in terms of technical know- how and upgrade products, supported by a slowdown in Moore’s Law, strong government support and rapid growth in investment.
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Exhibit 14. China’s presence in key IC product categories System Device Core IC China market share in 2016 Server Microprocessor unit (MPU) 0% Computing PC Microprocessor unit (MPU) 0% system Industrial application Microcontroller unit (MCU) 2% Field-programmable gate array General electronic Programmable logic device (PLD) 0% (FPGA) /EPLD system Digital signal processing device Digital signal processor (DSP) 0% Base band processor 18% Application processor 22% Mobile device Telecom equipment Embedded MPU 0% Embedded DSP 0% Core network equipment Network processor unit (NPU) 15% Memory DRAM 0% NAND Flash 0% Semiconductor memory chip Nor Flash 5%
Display and vision Graphic processor 5% High definition / smart TV system Display driver 0%
Source: CISA
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Moore’s Law is slowing down Moore’s Law states that the number of transistors will double per square millimetre every 18 months due to innovations in design, material and fabrication technology. Based on this thesis, Moore’s Law is likely to come to an end in the early 2020s, when nodes should shrink to around 5nm. Any further shrinkage would create huge technical and economic challenges in terms of over-heating and leakage issues with transistors, high capex and costs, and less performance gain per watt.
There is already evidence of longer node migration cycles for foundries. For Intel, it took around 27 months to migrate from 45nm to 32nm, 28 months from 32nm to 22nm and 30 months from 22nm to 14nm. The company launched 14nm CPU in 2014 but delayed the commercial launch of 10nm CPU from the end of 2017 to the end of 2019. TSMC’s former chairman, Morris Chang, commented in 2017 that Moore’s Law may face significant challenges by 2025 and said he believes processing costs might increase if foundries continue to shrink nodes beyond 2025.
We believe this creates more time for Chinese foundries such as SMIC to narrow the technology gap with global leaders. We also think this will also lead to more R&D investment in new materials such as graphene, III-V compound semiconductors and photonics in the coming decade, areas where China may have a higher chance of becoming a global leader.
On the other hand, the slowdown in Moore’s Law suggests that the technical challenges are growing exponentially, which may make it more difficult for Chinese vendors to close the gap with global leaders. This is why R&D investment and operational excellence remain the key areas of focus for Chinese companies.
Exhibit 15. Logic IC technology roadmap
2012 2013 2014 2015 2016 2017 2018e 2019e 2020e TSMC 28nm HKMG 20nm Planar 16nm FinFET 10nm FinFET 7nm FinFET 5nm FinFET Samsung 28nm PolySION 28nm HKMG 20nm Planar 14nm FinFET 10nm FinFET 7nm FinFET Global Foundries 28nm PolySION 20nm Planar 14nm FinFET 12nm FinFET 7nm FinFET Intel 22nm Planar 14nm FinFET 10nm FinFET SMIC 28nm PolySION 20nm Planar 14nm FinFET
Source: TechInsights, Company data, HSBC Qianhai Securities
China’s role in the development of technical standards such as 5G, AI and IoT China is becoming more active in setting technical standards in emerging industry applications China is becoming more active in setting technical standards such as 5G, AI, IoT, and autonomous driving. This deeper level of involvement means more influence and closer collaboration with semiconductor supply chain partners, which over time should enable leading Chinese companies to move up the value chain from software or system design to the IC design universe.
For example, in the area of telecoms the 3rd Generation Partnership Project (3GPP), a collaboration between groups of telecommunications standards associations, has chosen polar coding as the official coding scheme for the control channels of the 5G New Radio eMBB interface. Polar coding is the standard supported by Huawei, while Qualcomm and others support a standard known as LDPC. This provides Huawei with a competitive edge for Huawei in designing 5G baseband ICs. Elsewhere, in April 2018 Alibaba acquired C-Sky, a Chinese company engaged in the design of low power embedded 32-bit CPUs applied in IoT and cloud systems. This creates synergies for Alibaba as C-Sky’s CPU could be integrated with Alibaba’s AliOS. We discuss China’s presence in AI in a later section.
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Investment cycle to boost competitive edge China’s total IC capex in 2016 grew 31% y-o-y to RMB94.5bn (USD14.2bn), vs. 5% growth in global IC capex. As a result, China’s share of global IC capex increased from 7% in 2011 to 21% in 2016. As at 2016, China had 72 wafer fabs operating on over 6 inches technology platforms, 10 fabs of 12 inches, and 20 fabs of 8 inches.
According to IC Insights, aggregate capex by Chinese companies will increase from USD7.9bn in 2017 to USD11bn in 2018, exceeding the total investment by European and Japanese companies for the first time. The growth is being driven by capacity expansion for DRAM and NAND flash memory companies such as Hefei Changxin, Wuhan Xinxin/Yangtze Memory, Fujian Jinhua, in addition to foundries like SMIC and Huali. This substantial level of investment helps Chinese companies attract talent, as shown by the number of experienced executives from Taiwan working for leading Chinese IC companies.
Exhibit 16. China and global IC capex Exhibit 17. China headquartered semi trend capex vs. Japan and Europe 80.0 25% 12 (USDbn) 10.711.0 68.0 (USDbn) 70.0 65.8 64.8 64.6 10 9.5 20% 58.7 21% 20% 60.0 56.5 57.8 7.9 18% 7.5 8 7.0 50.0 16% 16% 15% 6.6 40.0 13% 6
30.0 25.9 9% 10% 3.9 4 7% 20.0 14.2 2.2 5% 9.4 10.4 11.5 1.5 7.2 2 10.0 5.2 4.7 5.5
- 0% 0 2009 2010 2011 2012 2013 2014 2015 2016 2014 2015 2016 2017 2018e China IC capex Global IC capex Chnia's share (right) Japan and Europe
Source: Wind, China Semiconductor Industry Association Source: IC Insights
Supportive government policies As mentioned earlier, the Chinese government is offering the industry a great deal of policy The Chinese government is offering the industry a great support. For example, the National IC Industry Development Guidelines in June 2014 contained deal of policy support a number of targets for 2020, including: 1) to keep the annual industry IC sales growth rate above 20% y-o-y during 2015-20 and reach over RMB870bn in 2020; 2) to reach tier-one level in IC design worldwide in mobile smart devices, network communication, cloud computing, Internet of Things and big data; 3) to achieve scale production in 16/14nm ICs by 2020, vs. 32/28nm in 2015; and 4) to achieve global standards in packaging and testing and enter the global supply chain for key equipment and materials.
Then, in May 2015, the State Council released the “Made in China 2025” plan, which laid out a detailed technology roadmap for various industries, including IC, covering design, manufacturing packaging, equipment and materials. We will discuss each segment in detail in the following section.
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Exhibit 18. IC industry development roadmap according to the “Made in China 2025” plan 2015 2020 2025 2030 65-40nm 28nm 20-14nm In line with global peers Manufacturing 0.2mn wafers/month (12') 0.7mn wafers/month (12') 1mn wafers/month (12') 1.5mn wafers/month (12')
28nm IC design 20-14nm IC design In line with global peers Design Market size of US$20bn, Market size of US$40bn, Market size of US$60bn, 35% global share 20% global share 25% global share
Market size of US$10bn, 35% global share Market size of US$20bn, 45% global share Packaging Multi-chip package (MCP) 3D Package Multi-component IC (MCO) Source: MIIT
The National IC Investment Fund Aside from policy support, China’s government is also providing large amounts of capital for the domestic IC industry. In September 2014, the National IC Industry Fund – known as the Big Fund – was established with initial capital of RMB138.7bn raised from state-owned enterprises (SOEs) and the government; investors included the Ministry of Finance, China Tobacco, China Mobile, China Development Bank, and China Electronics Corporation. The fund mainly invests in leading private and public listed domestic IC companies, with the focus on manufacturing and design which accounts for 65% and 17% of the fund’s total investment, respectively.
The Big Fund targets industry leaders across the value chain to help finance advanced capacity expansion and strategic acquisitions. As at the end of 2017, the first phase of Big Fund financing had invested in 62 projects, of which 23 are listed companies or affiliates of listed companies. A second phase of investment by the fund is underway, with funding expected to be in the range of RMB150- 200bn. The aim is to broaden sector coverage to applications for smart vehicles, AI, IoT, and 5G.
Exhibit 19. Major Big Fund investments in listed companies Related Company Listco Ticker Investment Ownership Comment (RMBm) Design May-15 Nine Star 002180 CH 500 4.0% To finance the acquisition of Static Control Components Jun-15 Goke Microelectronics 300672 CH 400 15.8% Pre-IPO investment Nov-15 Sanechips ZTE 000063 CH 2,400 24.0% Invest in IC design unit of ZTE Aug-17 Giga Device 603986 CH 1,450 11.0% Through share transfer from existing shareholders Nov-17 Goodix 603160 CH 2,829 6.65% Through share transfer from existing shareholders Jan-18 Jingjia 300474 CH < 1,170 n/a Pending approval. Jingjia specializes in GPU development Microelectronics Manufacturing Feb-15 SMIC 981 HK 2,700 15.1% New share issuance 2016-17 SMIC North SMIC 981 HK 9,970 32.0% Focus on 45-28nm IC on 12' wafer Jan-18 SMIC South SMIC 981 HK 5,963 27.0% Focus on 14nm IC manufacturing Jan-18 Hua Hong 1347 HK 2,520 18.9% To issue new shares Jan-18 Hua Hong (Wuxi) Hua Hong 1347 HK 3,289 29.0% To finance the investment in 12' production line Nov-16 Navtech 300456 CH 1,048 9.1% Through private placement to finance 8' MEMS fab Packaging Jan-15 JCET 600584 CH 2,031 9.5% To finance the acquisition of STATS ChipPAC Dec-15 Hua Tian (Xi'An) Hua Tian 002185 CH 500 27.2% Subsidiary of listco Dec-17 China Wafer Level CSP 603005 CH 680 9.3% Bought shares from Engineering and IP Advanced Technologies Jan-Feb 18 Tongfu Microelectronics 002156 CH 2,561 21.7% Through private placement to acquire AMD’s packaging facilities Equipmen t Feb-16 Naura 002371 CH 600 7.5% Through private placement to acquire North Microelectronics Jun-15 Chang Chuan Technology 300604 CH n/a 7.3% Pre-IPO investment Materials Oct-17 Yoke Technology 002409 CH 550 n/a To finance acquisition on special gas company Dec-17 Zhong Ju Xin Technology Zhejiang 600160 CH 390 39.0% To form JV in electronic material development Juhua Others Jun-15 San’an Optoelectronics 600703 CH 4,839 11.3% Through share transfer; Leading LED supplier Jul-16 BDStar Navigation 002151 CH 1,500 11.5% Through private placement; Satellite navigation
Source: Company data, HSBC Qianhai Securities
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Apart from the central government, a number of municipal governments are also raising capital and forming IC investment funds. The total size of these funds – including contributions from phase one of the Big Fund – amounts to RMB465bn.
Each municipal government has a different focus. For example, Hubei and Anhui are developing IC manufacturing due to their exposure to start-up memory foundries such as Yangtze Memory Technologies (NAND flash), Wuhan Xinxin (NOR flash), and Hefei Changxin (DRAM). Guangdong focuses on design and packaging, while Fujian intends to spend 70% of its RMB50bn fund on III-V compound semiconductors such as Gallium nitride (GaN), Gallium arsenide (GaAs), and Indium nitride (InN).
Exhibit 20. China’s IC investment fund map
HEILONGJIANG
JILIN Big fund INNER MONGOLIA RMB138.72bn RMB10bn
LIAONING
XINJIANG BEIJING RMB32bn
TIANJIN HEBEI RMB200m/year SHANXI RMB10bn NINGXIA SHANDONG QINGHAI RMB30bn
GANSU JIANGSU RMB71bn SHAANXI HENAN
XIZANG SHANGHAI HUBEI ANHUI (TIBET) SICHUAN RMB50bn RMB30bn ZHEJIANG CHONGQING RMB12bn JIANGXI HUNAN
RMB250m FUJIAN Local governments GUIZHOU RMB50bn investing in the semiconductor industry YUNNAN GUANGXI Xia Men RMB16bn GUANGDONG HONG KONG Total investment RMB15bn RMB465.17bn HAINAN
Source: SemiInsights, HSBC Qianhai Securities
Challenges remain
Despite the considerable amount of progress made in this industry in the last few years, China still has several hurdles to overcome. We highlight two in particular:
Restrictions on equipment imports and cross-border M&A. Based on the Wassenaar Arrangement that covers 42 states, there are export controls on certain types of semiconductor equipment and IC components to China, such as advanced lithography equipment and related key components, high-performance CPU, FPGA, DSP and MOSFET, among others. In addition, Chinese companies face growing difficulties in acquiring overseas semiconductor companies, due to concerns about intellectual property transfer. As a result, China has to rely more on self- development in order to compete with global peers.
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Semiconductor supply chain. China has limited exposure to semiconductor processing material, including raw silicon wafer, mask, photoresist, electric gases, chemical-mechanical planarization (CMP) materials, and packaging substrate. This means there is a heavy reliance on imports. For silicon wafers, China is only able to make solar-grade 6-inch silicon wafer and has just trialled the production of 8/12-inch. Domestic technology also trails in the area of electronic design automation (EDA).
Exhibit 21. Unsuccessful M&A deals involving Chinese companies Date Acquirer Target company Target company's business Jul-15 Unigroup Micron DRAM, NAND Flash Oct-15 Unigroup Western Digital SSD, HDD, NAND Flash Oct-15 Unigroup Powertech Technology IC Packaging and testing Dec-15 Unigroup SPIL IC Packaging and testing Dec-15 Unigroup ChipMOS IC Packaging and testing Nov-16 Canyon Bridge Lattice Semiconductor FPGA Dec-16 Fujian Grand Chip Investment Fund Aixtron MOCVD, PECVD Aug-17 GigaDevice ISSI SRAM, DRAM
Source: Company data
In the next section we highlight areas where we believe Chinese companies have a competitive edge or are well positioned to gain market share.
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Three opportunities
China is catching up rapidly in the area of IC design Semi equipment sales are set to grow rapidly in 2018; China is emerging as the key driver Market share gains in packaging and testing
We now identify the three parts of the semiconductor value chain where we believe Chinese companies are gaining strength, implying compelling growth opportunities for A-share listed semiconductor companies.
Opportunity 1: IC design: AI and NOR flash memory
Fabless IC companies that focus on design, engineering and marketing are playing a more important role in the industry these days. According to IC Insights, the revenue share of global fabless IC companies has increased from 18% in 2007 to 27% in 2017, led by Qualcomm, Broadcom, MediaTek, AMD, Nvidia and Marvell.
China is catching up at a rapid pace. Ten Chinese companies were ranked in the world’s top 50 China is catching up at a rapid pace IC design companies last year, up from one in 2009. Their market share in fabless IC sales has increased from 5% in 2010 to 11% in 2017 at the expense of rivals in the US and Europe.
If we include output by foreign companies in the country, China’s IC design industry revenue increased from RMB4.0bn in 2009 to USD30.7bn in 2017 (a CAGR of 29%) and its global market share has expanded from 7% in 2009 to 30% in 2017. The total number of IC design companies in China increased from 582 in 2010 to 1,380 in 2017.
Exhibit 22. Market share of fabless Exhibit 23. China and global IC design company IC sales by company revenue comparison headquarter locations 100 30% Japan (USDbn) 1% 90 25% 80 Europe 4% 70 20% 60 China 5% 50 15% 40 Taiwan 17% 10% 30
US 20 69% 5% 10
Other countries (mainly Broadcom) 0 0% 4% 2009 2010 2011 2012 2013 2014 2015 2016
0% 20% 40% 60% 80% Global IC design China IC design China's market share 2017 2010
Source: IC Insights Source: IC Insights, CSIA, HSBC Qianhai Securities
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Exhibit 24. Top 10 IC design companies in China by revenue Company 2017 revenue Major business (RMBbn) HiSilicon 36.1 Smartphone, baseband, set top box, camera, display, home network, IoT Unigroup 11.0 Smartphone application, baseband processor, RF, IoT, CMOS, TV chipset Sanechips 6.6 Smartphone modem, multimedia application, image, power and PA chip, wired network Huada Semiconductor 5.2 Smart card, MCU, RFID, Analog, display Zhixin Microelectronics 4.5 Smart chip used in power, telecom, environmental, finance Goodix 3.7 Fingerprint Silan 2.7 MCU, Power management, LED driver, Power Driver Module, Digital Audio, MEMS Focal Tech (Shenzhen) 2.8 Touch IC Galaxycore 2.5 Image sensor Vimicro 2.1 Surveillance camera SOC, neural processing unit, HD digital image module
Source: CCID, Company data, HSBC Qianhai Securities
Exhibit 25. Number of IC design Exhibit 26. China’s IC design revenue companies in China share by industry 1,600 Power 1,362 1,380 2% 1,400 Analog GPS 4% 0% 1,200 Telecommunication 45% 1,000 PC Smart card 7% 736 800 681 9% 632 582 569 600 534 Multi-media 400 12% 200 Consumer - electronics 2010 2011 2012 2013 2014 2015 2016 2017 21%
Source: CSIA Source: CSIA
The number of Chinese IC design start-ups is also encouraging and some are among the top- tier players in emerging industries such as AI and block chain. AI chips are mainly used in cloud data centres and user devices (smartphones, auto, computer vision), which are used for machine learning (training) and inference. By technology, AI processors includes CPU, GPU, DSP, FPGA and ASIC. According to Forest and Sullivan, the global AI chip market will grow from USD5.2bn in 2017 to USD15.3bn in 2020, implying a CAGR of 43.3%.
Recent developments at the company level include:
The neural processing unit (NPU) of Huawei’s Kirin 970 chip, which was developed to power its latest flagship smartphone Mate 10, is licensed from Cambricon Technologies, a successful Chinese start-up specialising in AI chips.
In May 2018 Cambricon also launched a cloud-based machine learning processor called MLU100 and a mobile device NPU 1M based on TSMC’s 7nm technology. Cambricon is the first company in the world to have AI processors operating in both cloud and devices.
Beijing-based Horizon Robotics has launched an embedded computer vision processor called Sunrise1.0 and Journey1.0 targeting autonomous driving and smart cities.
Deephi Tech, another Beijing-based company, has developed a proprietary Deep Learning Processing Unit (DPU) platform that aims to simplify and accelerate deep learning applications. The company was recently acquired by US AI giant Xilinx.
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Exhibit 27. AI chip supply chain
Mobile ADAS Computer vision Natural language processing Virtual reality Apple Mobileye Movidius Chipintelli Microsoft Inference on Qualcomm NVIDIA Unisound device Cambricon Horizon Samsung Robotics MTK
GPU FPGA ASIC Inference on NVIDIA Altera Google TPU cloud AMD Xilinx
GPU ASIC FPGA Training NVIDIA Google TPU Deephi (Xilinx) Cambricon Note: Chinese companies are highlighted in red
Source: Company data, HSBC Qianhai Securities
Progress is also being made in blockchain technology. Chinese companies such as Bitmain and Canaan, which specialise in crypto currency mining machines, had market shares of 67% and 21% in the fabless ASIC bitcoin mining equipment shipments in 2017, according to Frost & Sullivan. The consulting firm also forecasts that the size of the blockchain hardware market will increase from RMB19.3bn in 2017 to RMB98.5bn in 2020, a CAGR of 98.5%. ASIC-based hardware accounted for 71% of the blockchain hardware market in 2017.
ASIC chips are gaining popularity in AI due to their computing performance, energy efficiency, and the fact they can be customised. Frost & Sullivan projects the size of the addressable market of ASIC-based AI chips will surge from USD1bn in 2017 to USD4.6bn in 2020, and will account for 30% of the total market in 2020, up from 19% in 2017.
Exhibit 28. Global AI chip market size Exhibit 29. Market size of blockchain hardware 18.0 40 (USDbn) 15.3 (RMBbn) 35.6 16.0 35 2.1 29.6 6.9 14.0 30 60% CAGR 2017-20 12.0 5.6 25 43% CAGR 10.0 5.5 20 17.5 8.0 205% CAGR 2.9 15 28.6 5.2 2013-17 6.0 52% CAGR 3.1 24.0 10 8.7 0.7 4.0 1.4 14.6 0.6 1.9 5 3.4 4.6 0.1 0.6 1.3 0.8 7.3 2.0 0.1 0.0 1.6 2.6 0 0.2 1.0 0.0 2013 2014 2015 2016 2017 2018e 2019e 2020e 2012 0.3 2017 2020e Total blockchain hardware ASIC FPGA GPU CPU Non-ASIC based blockchain hardware ASIC-based blockchain hardware Source: Company data, Frost & Sullivan Source: Company data, Frost & Sullivan
We think the ultimate aim of Chinese companies is to create an eco-system covering computing architecture, processors, and application development platforms. To do this we believe it is critical to succeed in the AI processor market, as shown by the dominance of NVIDIA’s CUDA and Volta architecture and GPU (used by Tesla, DGX, and Titan), and Google’s Tensorflow platform and TPU processor.
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Exhibit 30. Comparison of major AI chips Chip Training Inference Pros Cons type rank rank General-purpose, already in servers and PVs, sufficient for CPU Series-processing is less efficient than parallel-processing N/A N/A inferencing Highly parallel, high performance, uses popular AI framework GPU Inefficient unless fully utilized 1 3 (such as CUDA) Reconfigurable functionality, good for constantly evolving Difficult to program, lower performance versus GPUs, no major AI FPGA 2 2 workloads, efficient framework High computing performance, highly energy efficient, fully Expensive, requires high volumes to be practical, quickly outdated, ASIC 3 1 customizable less flexible
Source: Company data, HSBC Qianhai Securities
The reality is that despite some encouraging proprietary developments in AI and blockchain, the technology gap with leading overseas fabless companies such as Qualcomm, Nvidia, AMD and MediaTek remains wide. We believe IP licensing and customization, plus the recruitment of talent and education can help Chinese companies catch up.
IP licensing plus customization There’s a growing trend for China to localize core IPs in PCs, servers and smartphones ICs via joint ventures with global leaders. For example, ARM sold a 51% stake in ARM Technology China to a group of Chinese investors for USD775m in June 2018. While the main aim of the investment is to acquire the sales and distribution business in China, we believe it also creates a closer tie-up with ARM. This should help Chinese companies better customize ARM IP and ultimately build their own IP portfolio with the help of ARM’s platform. As discussed above, Qualcomm and Apple currently have far better customization skills when it comes to ARM architecture but we think Chinese vendors such as HiSilicon will catch up over time.
Another example of this trend is AMD’s JV with Tianjin Haiguang Advanced Technology Investment (THATIC) to develop x86 based server CPU technology. AMD will license its x86 IP to the JV and the Chinese partner will do some customization. The JV started producing Dhyana series server CPUs in July 2018, based on AMD’s ZEN architecture.
Recruiting talent, strengthening domestic education Chinese memory companies have been offering attractive compensation and incentive schemes in order to recruit talent, especially from Taiwan. Around 450 employees from Inotera and Nanya Technology have joined Chinese memory companies in the past two years. The chairman of Yangtze Memory, Mr. Gao Qiguan, was previously the general manager of Nanya Technology and Inotera, and the global executive vice president of Unigroup, Mr. Sun Shiwei, was the former deputy chairman and CEO of UMC.
China is also enhancing advanced IC education in order to enlarge its domestic talent pool. The IC industry requires people with a wide range of educational backgrounds, including computer science, communication engineering, software engineering, electrical engineering, physics, chemistry, material science, and mechanical engineering. China recruited 589,800 post-graduates and 77,252 PHDs in 2016, up 64% and 33% compared to 2007, the highest number worldwide.
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Exhibit 31. China’s post-graduate and Exhibit 32. IC industry recruitment by PHD recruitment category in China in 2017
650 80 ('000) ('000) 75 General 600 purpose, Others, 5% 70 10% 550 65
500 60 Packaging & 55 testing, 6% R&D, 58% 450 50 Foundry, 3% 400 45 40 350 35 Sales and customer 300 30 support, 18% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Post-graduate (LHS) PHD (RHS)
Source: Ministry of Education Source: White Paper of China IC Industry Talents
Memory – gaining presence in DRAM, NAND and NOR flash China is in the process of ramping up DRAM and NAND flash memory production lines and gaining share in NOR Flash memory.
NAND flash Yangtze Memory, an entity invested in by Unigroup, the National IC Fund and the Hubei municipal government, is a pioneer in developing 3D NAND Flash in China. The company was established at the end of 2016 and is the parent company of Wuhan Xinxin (XMC). XMC is a major NAND and NOR flash memory foundry in China, which is jointly developing 32L 3D NAND with Spansion. The company has also partnered with the Institute of Microelectronics of Chinese Academy of Sciences in 3D NAND R&D. To speed its development, the company is recruiting experienced management and talent from leading global memory companies.
Total investment amounts to USD24bn, with phase one capacity of 300,000 pieces of wafer/month (12-inch), in the range of 14-20nm. The company started equipment installation in April 2018 and expects to start producing 32 layer 3D NAND in 4Q18, with initial orders being for 8GB USB flash cards. The company also plans to mass produce 128Gb and 64 layer 3D NAND from 2019.
Exhibit 33. 2D and 3D NAND flash node migration roadmap 2014 2015 2016 2017 2018 2019 2020
2D 19nm Samsung 16nm 14nm 3D V-NAND 32L (20nm) 48L (20nm) 64L (20nm) 96/128/192L
Toshiba 2D 19nm 15nm 1st 15nm 2nd Western Digital 3D 48L (19nm) 64L (19nm) 96/128L
Micron/Intel 2D 16nm 3D 32T (40nm) 64T (20nm) 96T (20nm), 128T
SK Hynix 2D 16nm 14nm
3D 36L (31nm) 48L 72L 96L-128L
Yangtze 3D 32L 64L Memory
Source: TechInsights, HSBC Qianhai Securities
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DRAM Fujian Jinhua, Hefei Changxin, and Ziguang Guoxin Microelectronics are the leaders in developing DRAM in China. Fujian Jinhua licenses 20nm DRAM IPs from UMC and intends to start mass production in 4Q18. Total investment amounts to RMB37bn, with phase 1 capacity of 60,000 pieces/month (12-inch). Ziguang Guoxin is a fabless IC design house. In 2015 it moved into DRAM by acquiring the Xi’an subsidiary of Qimonda, a memory company that is an affiliate of German tech company Infineon. Ziguang Guoxin is currently able to mass produce DDR3 DRAM (25nm process node), and plans to complete the development of DDR4 in 2018. We discuss Hefei Changxin in a later section of this report.
Exhibit 34. DRAM migration schedule by major DRAM vendors 1H14 2H14 1H15 2H15 1H16 2H16 1H17 2H17 1H18 2H18 2019e 2020e
Samsung 25nm 20nm 20nm 18nm 17nm
SK Hynix 25nm 21nm 18nm 17nm
Micron 25nm 20nm 17nm
Fujian 19nm Jinhua
Hefei 20nm Changxin
Source: Company data, HSBC Qianhai Securities
NOR flash: favourable demand/supply outlook Memory can be divided into volatile and non-volatile, based on the dependence on active power connection to function and persistence in storage. Non-volatile memory, which does not lose stored data when the power is off, includes flash and read-only memory (ROM). The prevailing form is flash memory. Based on a structure of interconnections between memory cells, flash memory is divided into NOR and NAND. NOR generally has low density, faster read speed, and good endurance, while NAND has high density, fast write and erase speeds and lower bit cost. Depending on interfaces, NOR flash can be further categorized into serial and parallel types.
Volatile memory mainly refers to random access memory (RAM). Based on the design Volatile memory mainly refers to random access architecture, RAM can be divided into dynamic (DRAM) and static (SRAM) type. RAM is used to memory (RAM) temporarily hold data. DRAM uses transistors and capacitors in an array of repeating circuits (where each circuit is one bit), whereas SRAM uses several transistors in a circuit to form one bit. SRAM offers a faster data input/output rate and is less sensitive than DRAM to disturbance such as electrical noise. It also does not require refresh, a process involving the periodic reading of information from a certain section of the memory and the immediate rewriting of that information to the same area without making any changes. But SRAM is generally more expensive than DRAM.
DRAM and NAND flash are the primary memory type, with their market size reaching USD72.8bn and USD47.2bn in 2017, accounting for 58% and 38% of the global memory market in terms of value. The NOR flash market reached USD2.0bn in 2017, representing only 1% of the total memory market.
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Exhibit 35. Memory product classifications Exhibit 36. Market size of memory industry in 2017
Memory (USDbn) Others, NOR Flash, 3.5 , 3% 2.0, 1%
Non-volatile Volatile
OTP EPROM Flash DRAM SRAM ROM EEPROM NAND DRAM, Flash, 47.2, Nor NAND 72.8, 58% Flash Flash 38%
Serial Parallel
Red box represents the GigaDevice’ product offering
Source: Company data Source: DramExchange, HSBC Qianhai Securities
Exhibit 37. Comparison of NOR and NAND flash
NOR flash NAND flash Interface in NOR allows random access for reading NAND allows only page access reading/writing Fast read and random access times Higher density Higher endurance and data retention Higher storage capacity Features Reliable code and data storage Fast write and erase speeds Low standby power Lower bit cost Lower density and wrote speed Higher read latency Code storage in PCs, feature phones, USB drives, SSD in tablets, smartphones, Applications consumer electronics, PCs, servers, etc. set-top boxes, autos, industrials, etc. Density Up to 4Gb Up to 1TB Node up to 45nm up to 12nm
Source: Industry data
Demand for NOR flash is expanding NOR Flash’s low read latency characteristics allow it to be widely used in read only, code storage/execution applications such as PC BIOS systems, feature phones, consumer electronics, autos, TV set-top boxes, surveillance cameras, and industrial machines.
The size of the NOR flash market declined from a peak of USD8.6bn in 2006 to a trough of USD1.5bn in 2015, but has started to pick up again in the past two years. This is primarily due to: 1) the decline in the unit selling price. According to WSTS, the average selling price of NOR flash has fallen from USD2.32 in 2006 to USD0.34 in 2017, an annualized decline of 16%; and 2) a structural change in demand. NOR flash was widely used in feature phones but has lost ground in the smartphone cycle since 2007.
Smartphones require much higher data storage capacity than feature phones, and also have more functions and a slimmer form factor, making NAND flash the preferred choice. But since 2016 NOR flash has started to pick up in both volume and price thanks to demand from new applications such as AMLOD panels, touch and display driver integration (TDDI) and advanced driver assistance system (ADAS), gaming consoles, as well as limited new supply.
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Exhibit 38. Global market size of NOR Exhibit 39. NOR flash shipments and Flash memory ASP worldwide 9,000 20% 6,000 2.50 (USDmn) (mn) (USD) 8,000 15% 10% 5,000 7,000 2.00 5% 6,000 0% 4,000 1.50 5,000 -5% 3,000 4,000 -10% 1.00 -15% 3,000 2,000 -20% 2,000 0.50 -25% 1,000 1,000 -30% - - - -35% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Shipment volume (LHS) ASP (RHS) Market size Yoy Source: WSTS Source: WSTS
Looking ahead, we highlight the key demand drivers for NOR flash:
AMOLED panels: smartphones The Mura effect, which refers to each pixel not being able to output colours identically in a display, is an issue for active-matrix organic light-emitting diode (AMOLED) panels. It results in poor colour and brightness consistency from one pixel to the next. Liquid crystal display (LCD) is generally better at minimizing the Mura effect. To ensure consistency in product quality, manufacturers have to set up automated inspection and repair processes. Codes that compensate for possible defects in each panel are stored in a separate, implanted NOR flash memory as it is not an economical solution to integrate a de-Mura function into an AMOLED driver IC. That said, NOR flash has become an essential part of AMOLED. A typical high- definition OLED smartphone panel contains an 8-16MB NOR flash chip.
We see an increase in the penetration rate of OLED smartphones in the coming years. OLED We see an increase in the penetration rate of OLED offers several advantages over LCD display: 1) slimmer form factor without backlight as it is smartphones self-emissive; 2) low power consumption; and 3) more vibrant colour, deeper blacks and brighter whites and better contract ratio. More smartphone models have recently started using OLED display, including Vivo X21, OPPO R15, and Xiaomi 8. Apple is also planning to launch two OLED iPhone models (5.8- and 6.5-inch) in 4Q18, vs. one model in 2017, according to Appleinsider.com. HSBC’s Korean technology team forecasts that the global smartphone OLED penetration rate will increase from 23% in 2017 to 29% in 2018e and 32% in 2019e. This suggests a y-o-y unit growth rate of 30% in 2018 and 15% in 2019.
On the supply side, we forecast OLED monthly production capacity will growth from 164,000 sheets in 2017 to 327,000 in 2018 and 494,000 in 2019, with a large part of the incremental supply coming from Samsung and Chinese vendors such as BOE, Tianma, China Start Optoelectronics Technology (CSOT), Visonox, and EverDisplay. The diversification of OLED supply will help to reduce the cost of OLED panels and accelerated adoption rates.
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Exhibit 40. Global OLED smartphone Exhibit 41. OLED capacity expansion trend adoption rate 600 30% 28% 700 (mn) ('000 sheets/month, 6G eqiuiv.) 578 500 23% 23% 25% 600
20% 500 400 20% 430 249 400 300 13% 15% 145 300 269 60 10% 54 45 200 10% 200 157 25 4 10 269 100 56 239 100 5% 33 1 189 - 143 - 55 - 33 - 0% 2015 2016 2017 2018e 2019e 2020e 2014 2015 2016 2017 2018e 2019e Samsung flexible OLED capacity LGD OLED capacity China flexible OLED capacity Global OLED smartphone shipment Global OLED smartphone adoption ratio Source: HSBC Research Source: Company data, HSBC Research
Touch display driver integration (TDDI) Integrating display and touch driver solutions was introduced by Synaptics in 2015. It combines the display and touch driver IC into one chip, which simplifies design and improves the device’s reliability. TDDI has other advantages, including: 1) preventing electrical display noise from interfering with touch sensing; 2) lower BOM (bill of materials). The in-cell display driver IC and touch sensor are mounted on the thin film transistor (TFT) glass, which enables one flexible printed circuit (FPC) for interfacing with display and touch. This means TDDI requires one less FPC and IC than a conventional design; and 3) a slim form factor as it has narrower borders to support narrow bezels, reflecting the popularity of bezel-less, full-screen phones.
WitsView, a market research company, expects bezel-less phones’ penetration to surge from 8.7% in 2017 to 44.6% in 2018 and 92.1% in 2021. Meanwhile, IHS forecasts that TDDI chip demand will grow from 220m in 2017 to 280m in 2018 and 410m in 2022, implying a 13% CAGR over 2017-22. We estimate TDDI’s penetration rate will increase from 15% in 2017 to 24% in 2022. TDDI is mainly used in Android models such as Huawei P, Honor, the Nova series, and Vivo X series.
The program to run display and touch drivers is quite large, especially for notched full screen as a more sophisticated algorithm is required to calculate the shaped corner areas’ parameters. This means that an external NOR flash memory is needed to store the code for TDDI. The memory density is around 4-16MB.
Exhibit 42. Illustration of TDDI and discrete touch/display solution
Touch panel Full In-cell Panel
Display panel
TDDI Display Driver
Display FPC Touch IC Display FPC Touch FPC
Main Board Main Board
Connector Discrete display and touch driver TDDI solution
Source: HSBC Qianhai Securities
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Exhibit 43. TDDI chip demand forecast Exhibit 44. Full screen phone penetration forecast 450 30% 100% (mn) 410 92.1% 400 380 90% 87.7% 350 25% 80% 350 320 71.6% 70% 300 280 20% 60% 250 220 15% 50% 44.6% 200 40% 150 10% 25.1% 26.9% 30% 22.6% 100 20% 8.7% 15.7% 50 5% 50 10% 4 0% 2.4% 0 0% 2017 2018e 2019e 2020e 2021e 2015 2016 2017 2018e 2019e 2020e 2021e 2022e Bezel less phone penetration Shaped cutting phone penetration TDDI TDDI Penetration (RHS)
Source: IHS, HSBC Qianhai Securities Source: WitsView
Automotive: growing density and wider applications drive growth NOR flash was initially used in vehicles’ radio systems due to its low density and reliability. With the growing electrification trend, more auto components need high-performing memory to improve the user experience and facilitate autonomous driving functions. NOR flash’s fast read nature (up to 500MB per second) boots up a vehicle’s operating system and turns on functions (such as infotainment and ADAS) instantly. NOR flash also offers a more stable performance in harsh environments such as extreme temperatures than NAND and DRAM. In addition, its longevity makes it ideal for use in dashboard display, front/rear cameras, and the power train, and may also suit light detection and ranging (LIDAR) in the future.
Different auto electronics systems require varied types and densities of memory. NOR flash is preferred for powertrain systems as it known for reliability and endurance. It requires memory to work at extreme temperatures (from -40 to +125 degree Celsius). Memory enhances conventional engines and enables new types of engines such as electric vehicles. NOR flash also improves transmission shift control, start/stop and advanced thermal schemes. Communication systems need multi-chip packages (MCP), which combine more than one type of memory technology. It needs to fit into tight spaces in communication modules and integrate with smartphones and other wireless devices. For infotainment and cluster systems, DRAM NOR and NAND and MCP are all needed to meet a variety of applications. NAND is used for storage such as contacts, maps, and media, while DRAM supports the bandwidth demands associated with high-resolution video. NOR flash provides head-up displays.
For ADAS, multiple types of memory are needed to complete three stage computing performance (sense, perceive, and act). Functions such as night vision, traffic sign recognition, adaptive cruise control, and parking assistance demand memory with the highest performance standards.
Central control operating systems are currently equipped with 128-256MB NOR flash memory, while driving recorder, infotainment, GPS, and ADAS functions (such as all-round vision, lane departure warning system, automatic braking system) generally need 512MB NOR flash or SLC NAND, plus 1-2GB DRAM.
Cypress Semiconductors, a leading US company, expects ADAS inclusion in mid-end vehicle models to be the key drivers for NOR flash memory in the coming years. The company forecasts that ADAS system shipments will increase from 133m in 2017 to 280mn in 2021.
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Accordingly, NOR Flash revenue should increase from USD58m in 2017 to USD121m in 2021, a 20% CAGR.
Cypress claims to have a 65% market share in the automotive NOR flash in 2017. Macronix is also increasing its exposure to auto, industrial and medical segments but the contribution from consumer electronics fell from 31% in 1Q16 to 24% in 1Q18.
Exhibit 46. NOR flash market size in Exhibit 47. Macronix NOR flash ADAS system revenue breakdown 300 140 280 (USDm) (mn) 1Q18 24% 30% 13% 13% 20% 120 250 4Q17 27% 31% 10% 10% 22% 121 100 3Q17 31% 31% 9% 8% 21% 200 2Q17 29% 32% 10% 7% 22% 80 150 133 1Q17 29% 30% 12% 7% 22% 60 88 58 4Q16 34% 29% 11% 6% 20% 100 40 3Q16 36% 25% 11% 8% 20% 2Q16 34% 26% 14% 8% 18% 50 28 20 1Q16 31% 22% 16% 4% 10% 17% 0 0 0% 20% 40% 60% 80% 100% 2015 2017 2021e Consumer Communication ADAS systems shipment (LHS) NOR Flash market size in ADAS (RHS) Auto Industrial, medical and automation Handset and others Computer Source: Cypress Semiconductor Source: Company data
IoT the long-term driver IoT systems contain an SoC chip comprising a microcontroller, RF, memory, sensor and other components. IoT chips generally need to be low cost, small in size with low power consumption, low density, fast read/execution and secure access to handle frequent communications between various types of devices.
An SoC normally has embedded non-volatile memory (NVM) such as Flash (eFlash) as it saves energy and time to copy code from external memory, which is widely applied in wearable devices. NOR flash is a preferred choice of eFlash due to its low cost, fast read and reliability. NOR flash offers lower cost for densities below 512MB, while NAND flash has bit cost advantage for higher density memory. External memory is also needed for devices that need high density, such as smart homes, e-readers, home gateways, set-top boxes, and WiFi routers.
Devices that need to execute in place (XIP) functionality require code execution directly from Flash memory without shadowing it to DRAM. NOR flash is a more robust technology that can reliably operate without the need for Error Correction Code (ECC). NAND flash requires a controller to manage the operation, including detecting and correcting errors in random memory location, managing blocks of that memory that have errors in them and relocating or mapping locations with errors to new locations that are error-free.
The IoT is still in the early stage of growth. Ericsson forecasts that the number of connected IoT devices will reach 19.8bn by 2023, up from 7bn in 2017, implying a CAGR of 19%. GSMA projects a total of USD1.8trn in IoT application service revenue by 2026, led by smart homes (USD441bn), consumer electronics (USD276bn), connected vehicles (USD273bn) and connected industry (USD164bn).
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Exhibit 48. Embedded NVM comparison Exhibit 49. IoT connected devices forecast
Density 35 4MB (bn) 30 1.3 10% CAGR for Fixed connected devices 8.8 phones eFlash 25 Mobile Customized 1.7 phone 2MB 20 PC/laptop/ta 1.4 blet One-time 15 programmable Short-range (OTP) 7.5 17.4 IoT 256Kb 10 Electrically erasable programmable Wide-area Multi-time programmable 1.6 19% CAGR for read-only memory (MTP) IoT devices IoT 4Kb EEPROM 5 eFuse 6.4 2.4 1 1K 20K 100K 0 0.6 Endurance 2017 2023e
Source: Company data, HSBC Qianhai Securities Source: Ericsson
Apart from the demand drivers mentioned above, we also see bit density increasing and new applications driving demand. These include: 1) PC BIOS upgrade. The 8th generation Intel Core CPU requires an upgrade of NOR Flash memory from 64MB/128MB to 256MB; 2) Nintendo Switch has NOR flash memory inside the game console.
NOR flash shipments in 2017 totalled around 5.7bn units, according to WSTS. We forecast that volume demand for NOR flash will rise at a CAGR of 5-10% over 2018-20e.
Supply chain consolidation favours Chinese vendors The NOR flash supply chain has migrated from the US and Korea to the Greater China region in The NOR flash supply chain has migrated from the US the past few years. In 2007, Spansion, Intel, Samsung and ST Microelectronics were the largest and Korea to the Greater NOR flash suppliers with over 80% market share. In 2008, Micron acquired Intel and China region STMicroelectronics’ NOR flash business to become the No. 2 vendor.
Micron and Samsung Electronics have since switched their focus from NOR flash to 3D NAND flash and the DRAM market, and their market share has declined over the past decade. Samsung discontinued NOR flash production in 2012. Meanwhile, Cypress entered the NOR flash industry by taking over Spansion in 2014. But since its strategy is to keep its overall gross margin at around 50%, it has phased out some low-margin NOR flash business and now focuses on the auto and industrial market; its gross margin for the segment is over 40%.
These changes in industry terrain are creating opportunities for Taiwan- and China-based companies such as Macronix, Winbond and GigaDevice to gain market share. We now take a closer look at the three companies’ capacity and product strategy.
Exhibit 50. Market share of NOR flash Exhibit 51. NOR flash product offering comparison 40.0% Node Density Voltage 35.0% Macronix Micron 46nm 128Mb-2Gb 1.65-3.6V Cypress 110-45nm 8Mb-4Gb 1.8-3.0V 30.0% Cypress/Sp Winbond 90-46nm 512Kb-512Mb 1.2-3.0V ansion 25.0% Macronix 130-55nm 512Kb-2Gb 1.8V-5.0V Micron GigaDevice 130-45nm 512Kb-1Gb 1.8-3.0V
20.0% Winbond 15.0%
10.0% GigaDevice
5.0% Others
0.0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Company data, SemiInsights, HSBC Qianhai Securities Source: Company data
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Macronix Macronix, a Taiwan company, provides NOR flash, NAND Flash and ROM products. NOR flash accounts for 44% of its 1Q18 revenue. Due to competition from Chinese competitors, it is shifting its focus to high quality, high density NOR flash. The company ran at full capacity utilization in 1Q18 and does not plan to expand production capacity in the foreseeable future.
That said, product mix optimization and a focus on high value-added products will be the key drivers. Its NOR flash bit shipments declined 21% y-o-y and 27% q-o-q (chip volume times density). This was mainly because of a fall in volume shipments in low-density products. Macronix expects 55nm plus NOR flash will account for 18% of its total sales in 2018, up from 3% in 2017.
Macronix has two major fabs for NOR flash. The 8-inch fab (Fab 2) focuses on 130-75nm nodes, with monthly capacity of 46,000 pieces of wafer. The 12-inch fab (Fab 5) mainly produces 75-55nm NOR Flash and 36-19nm SLC NAND, with monthly capacity of 20,000. The company indicates it can switch 55nm NOR flash capacity to 36nm NAND based on market demand.
Exhibit 52. Macronix NOR flash sales by Exhibit 53. Macronix NOR flash density node technology shipment index 100% 180 170 25% (1Q14=100) 160 164 90% 160 153 151 150 20% 144 142 37% 135 80% 40% 43% 140 15% 50% 50% 46% 47% 127 127 126 58% 53% 53% 55% 53% 119 10% 70% 120 113 114 112 60% 100 5% 100 50% 0% 80 40% -5% 50% 60 55% 51% -10% 30% 51% 50% 46% 49% 46% 43% 48% 46% 40 20% 42% -15% 20 -20% 10% 13% 6% 0 -25% 0% 0% 1% 1% 1% 2% 2% 3% 5% 1% 3%
1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2016 2017 2018e
4Q16 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 1Q17 2Q17 3Q17 4Q17 1Q18 ≤55nm ≤75nm ≥0.1um Density shipment Yoy Source: Company data Source: Company data
Winbond Winbond, listed in Taiwan, focuses on low- to medium-density Flash (NOR and NAND) memory, as well as specialty and mobile DRAM products. Flash memory accounted for 52% of its revenue in 4Q17. Winbond’s capacity will increase from 46,000 in 2017 to 52,000 pieces/month (12 inch) in 2018, of which 26,000 are related to Flash (NOR plus NAND). Given Winbond has a longer track record in NOR flash, we estimate it to account for over half of the total Flash capacity.
The auto and industrial segments are the main revenue drivers, with the percentage of total revenue increasing from 2% in 2012 to 19% in 2017. Winbond focuses on 90nm and 58nm NOR flash. It specializes in series NOR flash, an area where it is the No. 2 supplier in the world.
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Exhibit 54. Winbond revenue breakdown Exhibit 55. Flash revenue by geometry by application 40% 100% 7% 35% 37% 1% 12% 35% 34% 33% 90% 32% 34% 30% 31% 80% 30% 28% 29% 29% 25% 70% 57% 28% 56% 25% 28% 28% 53% 25% 23% 60% 20% 50% 18% 19% 15% 40% 30% 10% 11% 42% 7% 20% 37% 35% 5% 5% 10% 2% 0% 0% 2012 2013 2014 2015 2016 2017 2014 2015 2016 Consumer Communication Computer Car & Industrial 90nm 58nm 46nm
Source: Company data Source: Company data
GigaDevice Unlike peers that have in-house wafer fabrication facilities, Beijing-based GigaDevice uses a fabless model and relies on third party foundries and packaging companies to manufacture its products. It mainly uses SMIC and Wuhan Xinxin’s 12-inch fabs. SMIC has total capacity of 447,750 wafers (8-inch equivalent) in 1Q18.
GigaDevice signed an agreement with SMIC in September 2017 to purchase not less than RMB1.2bn of wafers by the end of 2018. In 2017, GigaDevice’s transactions with its top two material suppliers amounted to only RMB621m and RMB228m. We therefore believe GigaDevice plans to increase procurement from SMIC significantly in 2018.
Wuhan Xinxin is a dedicated Flash memory foundry and has monthly capacity of 10,000 pieces (12-inch) for NOR flash. Customers include ESMT, Cypress (Spansion), and GigaDevice. But due to supply constraints in raw wafers, it is not able to allocate additional capacity to GigaDevice. We believe GigaDevice may also partner with Huali Microelectronics for additional capacity.
While GigaDevice does not disclose detailed capacity data, by gauging the revenue size and capacity of Macronix and Winbond, we estimate GigaDevice’s actual production output required around 12,000 pieces/month capacity (12-inch) in 2017. We believe GigaDevice’s fabless model offers flexibility in terms of expanding and cutting capacity during the industry cycle. Given the strong outlook, we think the company will benefit from an increase in demand.
Balanced demand & supply outlook in 2018-20 Global NOR flash capacity was around 88,000 wafers a month in 2017. Winbond said at its 4Q17 analyst meeting that total wafer capacity for NOR has increased 13% y-o-y in 1H18 to approximately 100,000 pieces. We think this estimate factors in 25,000 pieces a month capacity from SMIC for GigaDevice (source: Taiwan Economic Daily, 13 November 2017).
However, given GigaDevice’s revenue growth (20% y-o-y growth in 1Q18), we believe the actual capacity is much less than reported. We forecast that GigaDevice’s utilized capacity will increase from 12,000 pieces in 2017 to 21,600 pieces in 2020. Other key suppliers may include Powerchip as the company started producing 65nm NOR flash from 4Q17 at its Hefei plant. We model 5,000/10,000/15,000 pieces in 2018/19/20. Given that US peers are phasing out capacity, we project a 5% decline in annual capacity over 2018-20e. As a result, the total NOR flash capacity will increase by 7%, 8%, and 8% in 2018/19/20, which fits in with our forecast of a 5-10% growth in demand during this period.
As node migration in NOR flash is quite slow these days, the increase in demand for a certain product category will generally translate into wafer volume growth. But since individual memory
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chip density varies, the total wafer equivalent capacity is not able to precisely reflect bit density changes due to product mix shift.
Exhibit 56. NOR flash capacity forecast ('000 12-inch pieces) 2017 2018e 2019e 2020e 2017-20 CAGR Macronix 30.4 30.4 30.4 30.4 0% Winbond 16.0 16.0 17.0 18.0 4% GigaDevice 12.0 15.0 18.0 21.6 22% Powerchip - 5.0 10.0 15.0 n/a Others 29.6 28.1 26.7 25.3 -5% Total 88.0 94.5 102.1 110.4 8% y-o-y 7% 8% 8%
Source: Company data, HSBC Qianhai Securities
Opportunity 2: Semi equipment – import substitution potential
Semi equipment sales to grow rapidly in 2018, China emerging as the key driver According to SEMI, the global semiconductor equipment market increased 37% y-o-y to USD56.6bn in 2017 and is expected to grow 11% y-o-y to a record high of USD63bn in 2018. The rapid growth is being driven by: 1) memory fab capacity expansion by Samsung and SK Hynix in Korea; and 2) a growing number of fab investments in China, including both domestic and foreign enterprises. As a result, equipment sales in China increased 27% y-o-y to USD8.23bn in 2017. China’s global share in equipment sales has risen from 7% in 2012 to 15% in 2017, making it the third largest equipment sales market worldwide.
While capex is likely to decline in Korea and Taiwan in 2018-19, SEMI forecasts that China’s spending on fab equipment will increase by 57% and 60% y-o-y in 2018 and 2019, and the country is likely to overtake Korea to become world’s biggest spender in 2019. This creates ample growth opportunities for Chinese semi equipment makers.
Exhibit 57. Global semi equipment sales Exhibit 58. Global semi equipment market share 60.0 100% 6% 7% 6% 5% 9% 6% 5% (USDbn) 3.2 90% 7% 6% 6% 5% 6% 3.7 50.0 80% 9% 11% 11% 15% 11% 11% 6.5 70% 20% 40.0 3.6 26% 25% 11.5 60% 33% 26% 30% 2.1 2.2 2.0 2.2 2.6 2.4 2.0 4.6 3.4 2.1 4.2 50% 7% 15% 30.0 1.9 5.5 12% 8.2 40% 13% 3.4 12.2 11% 16% 9.5 9.4 23% 9.6 18% 20.0 10.6 30% 2.5 4.4 16% 20% 32% 4.9 6.5 18.0 20% 19% 8.7 3.4 6.8 10.0 22% 7.5 7.7 10% 17% 22% 5.2 14% 11% 10% 8.2 8.2 5.3 5.1 4.5 5.6 0% 0.0 2012 2013 2014 2015 2016 2017 2012 2013 2014 2015 2016 2017 North America Korea China Taiwan Japan Europe Others
North America Korea China Taiwan Japan Europe Others Source: SEMI Source: SEMI
In China, 12 volume fabs have been constructed since 2014-15, increasing the level of equipment purchases. In the past, foreign companies dominated fab investment in China. However, with the launch of Chinese fabs such as NAND Flash Fab by Yangtze Memory Technologies, the DRAM fab run by Hefei Changxin, and Huahong’s 12-inch fab in Wuxi, domestic companies’ share of equipment spending in China will increase from 33% in 2017 to 45% in 2019. Our analysis shows the total capex of the 12-inch fabs currently under construction in China amounts to USD77.8bn, exceeding the total sales of equipment globally in 2017.
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While Chinese vendors are now only able to provide 28nm and above node equipment, we understand a sizable part of the capacity of the new fabs under construction is targeting below 28nm. As a result, we estimate the addressable market size for Chinese equipment on 28nm and above node is USD4bn in 2018 and USD6bn in 2019.
Exhibit 59. Number of fabs starting Exhibit 60. IC equipment sales in China construction 18 25.0 70% 16 (USDbn) 16 15 20.7 60% 14 13 20.0 12 12 11 11 50% 10 10 10 9 15.0 12.9 40% 8 6 5 30% 4 10.0 8.2 4 3 6.5 20% 2 4.4 4.9 5.0 3.4 0 2.5 10% 2014 2015 2016 2017 2018e 2019e China All other regions 0.0 0% 2012 2013 2014 2015 2016 2017 2018e 2019e
China Yoy Source: SEMI Source: SEMI
Exhibit 61. List of 12-inch fabs in China
Company Location Project Technology node Capex Capacity Date of construction Date of operation
(USDbn) (k/month) Under construction / planning Shanghai South China JV 14nm 10.2 70 Oct-16 2019 SMIC Beijing North China JV 28nm HKMG 3.6 35 n/a n/a Huahong Wuxi 65-90nm 2.5 40 Mar-18 2019 Huali Microelectronics Shanghai 28-14nm n/a 40 2016 2018 Samsung Xi'an NAND Flash 10nm 7.0 80 Mar-18 2019 SK Hynix Wuxi DRAM 10nm 8.6 60 Nov-17 2018 Wuhan NAND Flash / DRAM 24.0 300 Dec-16 2019 Yangtze Memory Nanjing NAND Flash n/a 300 n/a n/a Global Foundries Chengdu Logic 0.18-0.13um/22nm SOI 9.1 65 Feb-17 2019 JHICC Jinjiang DRAM 32nm 5.7 60 Jul-17 3Q18 Hefei Changxin Hefei DRAM 19nm 7.2 125 May-17 2019 Current 12 inch fab in China Shanghai 45/40nm-28nm n/a 17 Oct-05 Dec-07 Beijing 0.18um-28nm n/a 46 Sep-02 Sep-04 SMIC Shenzhen 65-55nm n/a 3 Nov-16 4Q17 Beijing North China JV 40/28nm Polysion 3.6 29 Jul-13 4Q15 Huali Microelectronics Shanghai 55-40-28nm n/a 35 Jun-10 Apr-11 Samsung Xi'an NAND Flash 10.0 120 Apr-12 May-14 SK Hynix Wuxi DRAM 10.5 140 2005 2006 Intel Dalian 3D NAND Flash/ CPU 65nm 8.0 60 2007 2010 TSMC Nanjing 16nm FinFET 3.0 20 Jul-16 May-18 Wuhan Xinxin Wuhan NOR Flash 32nm 4.5 30 2011 2012 Powerchip Hefei Driver IC 90nm 2.0 40 Oct-15 Oct-17 UMC Xiamen Logic 55-40nm 2.1 50 Mar-15 Dec-17 Tacoma Huai An Image sensor 65/55nm 2.4 20 Mar-16 2017 Source: Company data, HSBC Qianhai Securities
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Exhibit 62. Front-end wafer fabrication process
Incoming DEPOSITION LITHOGRAPHY ETCH STRIP CLEAN DEPOSITION WAFER
Put down the Create the Selectively Remove the Remove residues Deposit conducting insulating layers remove material photoresist mask and particles materials for the pattern mask to be patterned to create features device
Source: HSBC Qianhai Securities
Of this, wafer fabrication equipment (WFE), which is used in front-end semiconductor manufacturing, represents over 80% of the total spending, with the balance going on back-end processes such as probing, assembly and testing. The wafer fabrication process includes deposition, lithography, etching, stripping, and cleaning.
US and Japanese vendors are the leading semi-equipment suppliers while European companies such ASML have a dominant position in lithography equipment. Chinese companies are catching up but still lag behind global peers in terms of technical know-how, product range, and revenues.
Exhibit 63. Global semi equipment market Exhibit 64. Semi equipment capex by segment breakdown in 2016 Assembly, 4.4, (USDbn) (USDbn) 8% Others, 1.7, Lithography, 4% Test, 4.7, 8% Test, 3.7, 9% 10.5, 19%
Packaging & Other wafer assembly, processes, 4.1, 3.0, 7% 7%
Process diagnostics, 6.5, 12% Etch and clean, 14.8, 26% Wafer , 32.8, Deposition, 80% 11.5, 20%
Source: ASM, VLSI Source: SEMI
China’s government has assigned a number of R&D projects to leading domestic semiconductor companies, research institutes, and universities since 2008, an initiative known as the “02 special project”. This project covers advanced equipment and materials and has achieved several breakthroughs. As at May 2017, China was able to mass produce over 16 types of front end wafer fabrication equipment, mainly 28nm and above. In particular, AMEC’s 7nm etch equipment is now part of TSMC’s supply chain.
Naura is also able to provide a wide range of equipment and it supplies 28nm etch equipment to SMIC’s Beijing fab. Meanwhile, Shanghai Micro Electronics Equipment (SMEE) is one of the few vendors worldwide able to provide 90nm lithography equipment.
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Chinese companies are also catching up in back-end packaging and test equipment. They are able to produce 15 kinds of equipment and aim to lift the self-supply ratio to 50% by 2020 from 30% in 2015. In the 13th Five-Year Plan (2016-20) the target is to penetrate the 20-14nm segment and increase the self-supply ratio in equipment and material.
Exhibit 65. Product mapping of major semi equipment vendors
Applied ASML Tokyo Lam KLA ASM Advantest Naura AMEC Materials Electron Research Tencor Pacific AMAT US ASML US 8035 JP LRCX US KLAC US 522 HK 6857 JP 002371 CH Private FY17 revenue (USDbn) 14.5 10.3 10.2 8.0 3.5 2.2 1.9 0.3 0.2 Headquarter US Netherland Japan US US China Japan China China Product category Lithography No Yes No No No No No No No Etch Yes No Yes Yes No No No Yes Yes Clean Yes No Yes Yes No No No Yes No Deposition Yes No Yes Yes No No No Yes Yes Process diagnostics Yes No No Yes Yes No Yes No No Other wafer processes Yes No Yes Yes Yes Yes No Yes No Test No No Yes No Yes Yes Yes No No Assembly No No No No Yes Yes No No No
Source: Company data, HSBC Qianhai Securities
Exhibit 66. “Made in China 2025” technology roadmap for semi equipment industry 2015 2020 2025 2030
Manufacturing 90-32nm equipment, to 20-14nm equipment, with 18-inch wafer equipment Equipment reach 50% self-sufficiency 30% self-sufficiency ratio
Lithography 90nm equipment Immersion Lithography EUV Lithography
Manufacturing 65-32nm equipment, to 22-14nm equipment, with To realize full self- Materials reach 50% self-sufficiency 50% self-sufficiency ratio sufficiency
Package equipment 30% self- 30% self-sufficiency To realize full self-sufficiency & materials sufficiency ratio ratio
Source: MIIT, HSBC Qianhai Securities
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Exhibit 67. List of major Chinese semi equipment vendors Company name Major products Plasma etcher, physical and chemical vapor deposition (PVD/CVD) Naura oxidate/diffusion, cleaning tool, indexer, gas measuring control LCD, LED, and solar equipment Plasma etcher on dielectric and polysilicon film, including reactive ion AMEC etching (RIE), through-silicon via (TSV), MOCVD. Shanghai Micro 90nm lithography, wafer optical inspection, material transport robot Electronics Equipment wafer aligner/bonder, wafer edge exposure equipment CETC Electronics Ion implanter, Chemical mechanical planarization (CMP) Equipment Group Electrochemical deposition (ECD), packaging equipment Plasma enhanced electric chemical vapor deposition (PECVD) Piotech Atomic layer deposition (ALD) Raintree Scientific Optical inspection equipment Instruments Han’s Laser Ultraviolet laser slicing, wafer modification cutting, laser stripping ACM Research Single-wafer megasonic cleaning tools KingSemi Coater, developer, cleaner, wet etcher, striper
Source: Company data, HSBC Qianhai Securities
Laser source’s self-sufficiency ratio is increasing As at 2016, China was able to produce 85% and 50% of its low-power (<100W) and mid-power (100-1,000W) laser source needs, but had limited capabilities in the high-power (>1,000W) category, which is dominated by overseas vendors such as IPG, Coherent, Trumpf, and nLight.
Chinese companies such as Raycus Laser and Han’s Laser have started to penetrate the high power market, with output up to 10KW. This could significantly lower the overall manufacturing cost for Chinese laser equipment makers and reduce reliance on imports at a time of rising trade tensions between the US and China.
IPG’s gross margin was 57% in 2017, which suggests that is should be possible to reduce laser sourcing cost via domestic production. The total market size of laser sources increased from USD9.0bn in 2013 to USD12.4bn in 2017, a CAGR of 8.5%. Opportunity 3: IC packaging and testing – market share gains
Outsourcing and consolidation favours leading OSAT The packaging and testing market accounts for a mid-teens percentage of global IC industry output. In China, however, the figure was 35% in 2017, indicating its heavy reliance on this segment. Packaging and testing is the IC segment where China’s technology gap with global peers is the smallest.
The global market can be divided into IDM in-house packaging and testing, and OSAT. According to Gantner, in 2016 the share of IDM in-house and OSAT was 48% and 52%, respectively. We think IDM will outsource or spin off some of the packaging and testing services in an environment of rising investment in advanced packaging technology. Hence, the market growth of OSAT should be slightly faster than for IDM.
As the semiconductor industry enters a mature stage, competition is intensifying. Similar to the upstream design house and foundry industry, the OSAT market is also consolidating as the leaders seek larger economies of scale and better technology to remain competitive.
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Earlier this year ASE, the largest OSAT company, merged with SPIL, the No. 4 company. The new giant has nearly 30% of the OSAT market. In 2016, Amkor acquired J-Device, the largest OSAT in Japan, and Nanium, a leading OSAT company in Europe, in 2017. PTI ( ) acquired Micron Akita in 2017, a packaging and testing site of Micron in Japan. JCET acquired STATS ChipPAC in 2014, and Tongfu bought an 85% stake in two AMD packaging and testing fabs in 2016.
According to TechSearch, the number of OSAT companies worldwide is over 100, but the top 10 represent nearly 75% of the market. Taiwan now has the strongest presence in OSAT, followed the US, China, and Singapore. China’s IC packaging and testing market reached RMB189bn in 2017, a 15.2% CAGR since 2005, outpacing the global packaging and testing market. Among the top 10 global OSATs, revenue generated by China’s top three OSATs – JECT, Huatian, and Tongfu – increased from 6.6% in 2011 to 21.2% in 2017.
Exhibit 68. Market share among top 10 Exhibit 69. OSAT M&A activity global OSATs 100.0% Year M&A events 17.0% 16.4% 15.5% 15.6% 22.1% 21.5% 18.2% 2013 Amkor acquired Toshiba's P&T operations in 80.0% Malaysia. 8.7% 9.8% 13.2% 6.6% 7.5% 19.1% 21.2% UTAC acquired Panasonic's P&T operations in 13.3% 13.5% 13.4% 14.0% 12.7% 2014 60.0% Singapore, Indonesia and Malaysia. 11.5% 10.5%
17.7% 17.0% 17.0% 16.0% 14.1% 16.9% 16.1% Tianshui Huatian acquired FlipChip International. 40.0% 2015 JECT acquired STATS ChipPAC. Amkor acquired J-Devices.
42.6% 43.3% 43.6% 20.0% 40.3% 40.5% 37.0% 36.6% 2016 Tongfu and National IC Fund acquired 85% stake of AMD's P&T operations in Malaysia and China. 0.0% PTI increased its stake in Tera Probe to nearly 60% and acquired Micron Akita. 2011 2012 2013 2014 2015 2016 2017 2017 ASE Amkor SPIL China top 3 OSATs Others Amkor acquired NANIUM.
2018 ASE merged with SPIL.
Source: Company data, HSBC Qianhai Securities Source: HSBC Qianhai Securities
China is benefiting from upstream capacity expansion We expect growth in China’s packaging and testing market to remain robust in the coming years thanks to upstream capacity expansion. SEMI estimates that 62 wafer fabs will come start operations between 2017 and 2020, of which 26 are located in China. These new fabs will bring new orders to Chinese packaging and testing companies.
Exhibit 70. China packaging and testing Exhibit 71. China top 10 packaging and market trend testing companies by revenue (RMBbn) 200 189 (RMBbn) Ranking Company Revenue 180 1 Xinchao Group 24.26 156 160 (JCET's parent Co) 138 2 Huada Group 19.88 140 126 15.2% CAGR (Tongfu's parent Co) 120 110 104 3 Tianshui Huatian Group (Huatian's 9.00 98 100 parent Co) 80 4 Qorvo 7.89 63 62 63 5 NXP 6.45 51 60 50 6 Intel 4.00 40 34 7 Amkor 3.95 20 8 Hitech 3.50 9 KaiHong 3.00 - 10 SanDisk 2.94 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: CSIA Source: CSIA
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Advanced packaging is moving into the mainstream as manufacturers seek ways to improve device performance. The semiconductor industry is also witnessing increasing investment from packaging houses in terms of capabilities, capacity, and infrastructure. This is driven by the need to deliver integrated, high-performance devices while addressing concerns about cost, power consumption, and size.
Advanced packaging has two development paths: 1) size reduction, i.e. reducing chip size close to the die size; typical platforms include FC (Flip-Chip) and Fan-in/Fan-out WLP (Wafer Level Packaging); and 2) functional development, i.e. emphasis on integration to provide multi- functions in system miniaturization; platforms include TSV (Through-Silicon Visa) technology + SiP (System in Package).
Exhibit 72. IC packaging technology trend
1970s 1980s 1990s 2000s
Through hole Surface Area array High density mounting mounting surface packaging
- TO, DIP - SOP,QFP - BGA, CSP - WLP, 3D stacking - Mounted on the PCB - Lead replaces pin, - Solder ball replaces - Reduce packaging though holes, the packaging size is lead, area array thickness or stack packaging size is fixed and peripheral surface mounting more than two dies in increased with I/Os pitch changes - 40-60I/Os/cm2 the same packaging number of I/O according to without changing the requirements - Greatly improved - ≤10 I/Os/cm2 packaging size I/O number, low - 10-50I/Os/cm2 2 - Strong, reliable, power consumption - ≥60I/Os/cm good heat dissipation, - Improved I/O - High integration, low easy wiring number and assembly power consumption density
Increasing I/O; Increasing Functionality
Source: HSBC Qianhai Securities
Yole Development, a consulting firm, estimates that the global advanced packaging market was worth USD24bn in 2017 and will reach USD34bn in 2022, accounting for 45% of the total packaging market and representing a CAGR of 7%. This outpaces the 3-4% CAGR of the overall packaging market and the 4-5% CAGR of the semiconductor market.
Yole expects the growth in the advanced segment to be led by smartphones and tablets. Other high-volume applications include servers, PC, game stations, HDD/USB, WiFi hardware, base stations, TVs and set top boxes. FC is the mostly used platform with 81% market share in 2017, while Fan-out is the fastest growing advanced packaging platform with a 36% CAGR, followed by the 2.5/3D TSV platform (28% CAGR). By 2022, the market size of Fan-out and 2.5D/3D TSV is expected to exceed USD3bn and USD1bn, respectively.
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Exhibit 73. Advanced packaging revenue Exhibit 74. Advanced packaging wafer by platform share by manufacturer 40.0 (USDbn) 35.0 (2.5D/3D 28%*) Intel 30.0 7% CAGR 12%
25.0 Others (Flip Chip 5%*) 33% SPIL 20.0 12%
15.0 JCET/STATS 10.0 ChipPAC 8% 5.0 (Fan-in 8%*) (Fan-out 36%*) Amkor ASE 0.0 6% 8% 2017 2022 TSMC ChipBond * CAGR 2017-2020 7% Fan-in Fan-out Flip Chip 2.5D/3D 8%
Samsung 7%
Source: Yole Source: Yole
According to Yole, the advanced packaging revenue generated from Chinese companies was USD2.2bn in 2015, and will reach USD4.6bn in 2022, a 16% CAGR and about 2x faster than the growth in the global advanced packaging market.
Through in-house R&D and acquisition, domestic packaging and testing companies have broadly caught up with international peers in terms of technology. They are still lagging behind in some specific platforms, such as high density Fan-out.
At present, the top three Chinese OSATs – JCET, Huatian and Tongfu – have mastered the 16/14nm FC packaging technology. JCET now owns leading-edge Fan-in/Fan-out and SiP technology through the acquisition of STATS ChipPAC. It has shipped more than 1.5bn low- density Fan-out chips.
Tongfu obtained high IOs density FC-BGA packaging technology through the acquisition of AMD Suzhou and Penang fabs. Huatian’s TSV+SiP fingerprint identification packaging product has been used in Huawei smartphones. Meanwhile, WLCSP ( ) has become one of the world’s largest image sensor WLP (Wafer-Level Packaging) suppliers. According to the China Semiconductor Industry Association, domestic packaging and testing companies contributed 32% of China advanced packaging market in 2016.
Exhibit 75. Advanced packaging revenue Exhibit 76. Fan-out packaging applications from Chinese companies focus for player
5.00 IO count 4.66 (USDbn) 10000 4.50 4.01 SPIL 4.00 High density, Fan-out, TSMC 16% CAGR 3.45 Amkor 3.50 First level, APE ASE 2.97 1000 TSMC 3.00 Core Fan-out High density, Fan-out, Second 2.56 level, networking, etc… Samsung 2.50 2.21 Nepes ASE JCET/ 2.00 Amkor/ STATSChipPAC 100 1.50 Nanium SPIL Deca Technologies Package size 1.00 (mm x mm)
0.50 2x2 5x5 10x10 15x15 20x20 >20x20 >>20x20 Different Fan-out platforms for different applications…and different suppliers. - 2015 2016 2017e 2018e 2019e 2020e Source: Yole Source: Yole
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The potential to improve margins and ROE The top Chinese OSATs on average generated a gross margin of 14.7% and ROE of 5% ROE in 2017. This is considerably lower than their Taiwan/US peers, which recorded average gross margins of 19.2% and ROE of 14.3%.
We believe this is primarily due to: 1) product mix differences, as fabless and IDM customers normally place new orders to offshore OSATs and gradually migrate orders to onshore peers as products become more commoditized; and 2) it will take time for JCET and Tongfu to integrate their newly-acquired assets. With the ongoing product upgrades and cost structure optimization, we expect to see improvements in margin and ROE in the years ahead.
Exhibit 77. Gross margin comparison of Exhibit 78. ROE comparison of OSATs OSATs 25.0% 18.0%
20.7% 16.0% 20.4% 19.3% 20.1% 19.9%20.1% 20.0% 19.2% 14.0% 17.6% 18.2% 15.8% 16.0% 12.0% 14.7% 15.0% 10.0% 8.0% 10.0% 6.0%
4.0% 5.0% 2.0% 0.0% 0.0% ASE SPIL Power Tech JCET Huatian Tongfu 2012 2013 2014 2015 2016 2017 Offshore Onshore 2012 2013 2014 2015 2016 2017
Note: offshore companies include ASE, SPIL, Amkor, and Power Tech Onshore companies include JCET, Huatian and Tongfu Source: Company data Source: Company data
Growth drivers shifting from mobile to auto and IoT Although the PC and mobile segments will remain the largest part of the IC market, automotive and IoT are expected to be the fastest semiconductor growth segments in the coming years. Due to the slowdown in the smartphone market, OSATs’ margins face downward pressure. Despite the long qualification process, the packaging technology applied in auto and IoT is not as advanced as in smartphones, making the competitive landscape more competitive.
Traditional lead frame products are by far the largest type of automotive packaging as they have proved to be very reliable components. Due to the long product life cycle, lead frame packages selected over a decade ago are still being manufactured for the same applications. This is not to say that non-lead frame packaging is absent from today’s vehicles.
Due to the increasing complexity and higher performance, pin count, power, and cost requirements of automotive applications, the packaging industry is moving towards high performance packages such as flip chip or wafer level fan-out packaging for automotive infotainment, GPS, and radar applications.
Since IoT products are driven by the need for the smallest form factor (think wearables) and ultra-low power (for longer battery life), the electronic components for these products must also meet these criteria. System-in-package (SiP) technology is the trend, it allows multiple die to be placed within a package molding in a variety of configurations to help solve these size and low- power design challenges.
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Exhibit 79. Share of 2017 IC sales and market size CAGR (2016-21)
30.0% (US$ bn) Cellphones $89.7
25.0% Standard PCs $69.0
20.0%
15.0% Share of 2017 IC sales IC 2017 of Share
Automotive $28.0 10.0%
Game Consoles Servers $16.7 $10.5 Digital TVs $13.8 5.0% Set-Top Boxes Medical $5.9 Tablets $11.6 $5.8 IoT $20.9 Gov/Military $2.6 Wearables $3.5
0.0% -3.0% 0.0% 3.0% 6.0% 9.0% 12.0% 15.0%
2016-21 CAGR -5.0%
Source: IC Insights
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Company updates
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Naura (002371 CH)
Leading IC equipment vendor with a comprehensive product portfolio The company invests heavily in R&D. Multiple growth drivers in IC, display, PCB, and electronic components Initiate with a Buy rating and a target price of RMB63.97
China’s largest semiconductor equipment company
Naura Technology Group is a leading manufacturer of advanced electronic equipment and precision components. Its products cover a range of industries, including semiconductors, LED, photovoltaic, display, and aerospace. The company was established in 2001 and was listed on the Shenzhen Stock Exchange in 2010. It was previously known as Sevenstar Electronics, an SOE owned by Beijing SASAC that engaged in semiconductor cleaning and oxidation/diffusion equipment, lithium battery, vacuum equipment for PV, as well as high-precision electronic components.
In 2016, Sevenstar merged with North Microelectronics (part of the parent company) and expanded its semiconductor equipment product portfolio to etching, PVD, CVD advanced packaging and LED equipment. This enabled Naura to become China’s largest semiconductor equipment company in terms of revenue. Key customers include SMIC, Huali Microelectronics, San’An, HC SemiTek, BOE, and Longi Silicon. The company has four manufacturing centres in Beijing – Yizhuang, Shunyi, Pinggu, and Chaoyang – and one in the US.
Exhibit 80. Naura organization chart Exhibit 81. Naura’s business portfolio
Beijing SASAC Naura Technology Group 100% Semiconductor equipment Beijing Electronics Holding Co Vacuum Lithium battery equipment for PV equipment LED Etch Cleaning 100% equipment
Display Beijing Sevenstar Huadian PVD MEMS National IC Investment Fund equipment Precision Technology Group component Oxidation/ CVD Power IC 38.9% 9.23% 7.5% Diffusion
Naura (002371 CH) Assets from North Microelectronics Mass flow controller
Source: Company data Source: Company data, HSBC Qianhai Securities
R&D investment in 2015-17 accounted for between 29% and 47% of its total revenue. Naura is heavily involved in the government’s “02” R&D initiative and has undertaken 12 research projects. As a result it has completed the development and commercialization of a number of products and processes, including 12 inch 90-28nm etcher, PVD, oxidation, cleaning and low pressure chemical vapour deposition (LPCVD). As at end 2017, Naura had applied for over 3,000 patents, and more than1,600 have been granted.
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Exhibit 82. Revenue and profit trend Exhibit 83. Naura’s patents – applied for and authorized 3,500 2,500 (RMBmn) 2,937 3,013 3,000 2,627 2,000 2,500 2,226
1,500 2,000 1,701 1,621 1,340 1,371 1,500 1,233 1,000 1,055 1,018 1,000 835 790 619 475 500 500 348
- - 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Accumulative patents applied Accumulated patent authorized Semiconductor Electronic component Vacuum Lithium battery Others Source: Company data Source: Company data
Semiconductor equipment: gaining traction with customers In 2017, sales of semiconductor equipment totalled RMB1,134m in 2017 – RMB400m from IC equipment, RMB500m from LED, RMB130m from display and the rest from solar equipment. Its IC equipment product portfolio covers etch, PVD, CVD, oxidation/diffusion furnace, cleaning tools, and mass flow controllers. Naura has accumulated abundant proprietary know-how and IP in IC equipment in the past decade and can now commercially scale a portfolio covering 90- 28nm technologies and is currently undertaking R&D for 16/14nm.
Exhibit 84. Major milestones of Naura’s IC equipment business Year Events The first 300mm diffusion furnace passes customer qualification and starts commercial sales 2012 R&D of 300mm mass flow controller (MFC) completed and enters commercialization phase 300mm oxidation furnace enters mass production 2013 300mm MFC realizes commercial sales; 65mn cleaning tool receives national qualification Sample shipment of 45-32nm LPCVD equipment 28nm 300mm oxidation furnace meets technical requirements of SMIC 2014 Complete testing of 65-45nm cleaning tool for SMIC; 45-32nm LPCVD under development Completes 7 equipment sales of 300mm 90/65nm oxidation furnace and MFC 2015 Continues to test 32-28nm LPCVD project within SMIC Starts R&D of 28-14nm Atom Layer Deposition (ALD) Completes the merger with North Microelectronics, thus expanding product portfolio to etching, 2016 PVD, CVD Accelerates its R&D in 16/14nm equipment Proposes to acquire Akrion System, US based semi cleaning equipment company, for USD15mn 2017 Signs over RMB1.2bn supply contract with Longi on mono silicon furnace 2018 Completes the acquisition of Akrion, US-based cleaning equipment company
Source: Company data
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Exhibit 85. Naura’s major products and functions Name Description A process for removing material in a specific area through a chemical reaction or physical bombardment. Etch The process can be performed using liquid-phase (wet) etchants or under vacuum (dry) typically using a plasma to generate gas-phase reactants A process technology in which atoms of conducting materials are sputtered from a target of pure material PVD then deposited on the substrate to create the conducting circuitry within an IC or a flat panel display. A process for depositing thin films by exposing the substrate to one or more volatile precursors, which CVD react and/or decompose on the substrate surface A way to produce a thin layer of oxide (usually SiO2) on the surface of a wafer. This forces an oxidizing Oxidation agent to diffuse into the wafer at high temperature and react with it Cleaning A process to remove unwanted material or contaminants from substrates Source: Company data, HSBC Qianhai Securities
Its major customers include SMIC, Huali Microelectronics, Yangtze Memory, and Shanghai IC R&D Center. SMIC accounted for over 60% of Naura’s IC equipment revenue last year. The company started to supply IC equipment to SMIC in 2011 and began testing 28nm equipment in 2014; its PVD has become the baseline equipment for SMIC.
Naura and AMEC’s etcher products are based on dry etching technology that uses plasma to remove unwanted material from silicon wafers. Based on the type of plasma, it can be divided into inductively coupled plasma (ICP), capacitively coupled plasma (CCP) and microwave electron cyclotron resonance (ECR) plasma. Naura specializes in ICP, while AMEC focuses on CCP.
Exhibit 86. Naura’s IC equipment Exhibit 87. AMEC’s accumulative IC shipments equipment sales 1,200 800
(cavity) 700 1,000 600 800 500
600 400
300 400 200 200 100
- 0 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 Etch PVD CVD Oxidation Cleaning D-etch TSV/ICP MOCVD Total Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Looking ahead, we believe capacity expansion by key customers and the construction of new fabs is creating opportunities for Naura. For example:
In 2018 SMIC has budgeted USD1.9bn in capex for foundry, with USD500m and USD400m to be spent on expanding the capacity of its majority-owned Beijing 300mm fab and its new 200mm Tianjin fab.
Naura delivered an oxidation furnace to Yangtze Memory in November 2017 and recently won bids to supply the company with etcher and PVD in 2018. For Huali, the company has installed a 14-20nm advanced lithography equipment from ASML in May 2018 in Shanghai, suggesting that Huali is in process of ramping up its new 300mm fab. Naura signed a framework contract with Hefei Changxin in April 2018. The company will fully assess, test and jointly develop equipment with Naura.
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Naura estimates that domestic equipment represents only 5% of the spending on equipment by major Chinese foundries, suggesting opportunities for Naura in the coming years. It takes around four years from R&D to commercialization – two years’ in-house development and two years’ on-site testing and review. The average selling price (ASP) for etcher, PVD and CVD is around RMB20-30m and RMB10m for cleaning and oxidation equipment.
Exhibit 88. Etcher equipment classification Product Key customers Accumulative sales Etcher SMIC, Yangtze Memory Over 600 cavities PVD SMIC, Leadcore Technology, Yangtze Memory Over 100 cavities CVD SMIC, Shanghai IC R&D Center Over 200 cavities Oxidation/Diffusion SMIC, Huali Microelectronics, Yangtze Memory Over 100 cavities Cleaning SMIC, Yangtze Memory Over 100 cavities
Source: Company data
Apart from organic growth, Naura also relies on M&A to drive revenue growth. In 2017, Naura offered to acquire 100% of Akrion Systems, a US-based semiconductor equipment vendor, for USD15m and the transaction was completed in January 2018. Akrion is a leading supplier of surface preparation equipment (such as cleaning/stripping) for silicon wafer, semiconductor devices, flat panel displays, MEMS, and solar.
Akrion has over 20 years of experience and has installed over 1,000 systems worldwide. Seven out of the top 10 foundries, and five out of top 10 MEMS manufacturers are Akrion customers, including Globalfoundries, and STMicroelectronics. It has over 80 employees and 8,500 square inches of manufacturing facilities and 2,000 square inches of labs.
This acquisition is helping Naura to broaden its customer base and enhance its service capability (Naura intends to introduce Akrion’s products to SMIC in 2018). Akrion also announced strong bookings in 1Q18, indicating it will ship to existing and new customers in the US, China and Southeast Asia this year. While Akrion generated RMB106m and RMB80m in revenue in 2015 and 2016 it incurred net losses of RMB20m and RMB23m, respectively, after stripping out interest-bearing loans and cash (which are not within the scope of the acquisition).
Exhibit 89. Chinese equipment supplier for front-end IC manufacturing Category Product Supplier Lithography Shanghai Microelectronics equipment Lithography Coater/developer Kingsemi (Shenyang) Photoresist Strip Naura, Mattson (Beijing) Etch Etcher Naura, AMEC, Mattson (Beijing) Surface treatment Clean Naura, ACM Research (Shanghai), Oxidation/diffusion Naura Thermal Single-wafer anneal Naura treatment Fast anneal Mattson (Beijing) Ion implantation Ion implantation Kingstone LPCVD Naura CVD ALD Naura, Piotech (Shenyang) PECVD Naura, Piotech (Shenyang) PVD PVD Naura
Source: Company data, HSBC Qianhai Securities
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LED equipment: riding the wave of capacity expansion by Chinese chip makers Revenue from LED equipment surged 50% y-o-y to around RMB500m in 2017. The manufacturing process for LED chips can be divided into front-end epitaxy wafer processing, middle-end chip manufacturing and back-end packaging. Metal organic chemical vapour deposition (MOCVD) is the key equipment in epitaxy wafer processing, with vendors such as Veeco, Aixtron and AMEC. Mid-end chip manufacturing involves multiple steps including lithography, etching, cleaning, metallization, and anneal.
Naura supplies ICP etcher, plasma-enhanced chemical vapour deposition (PECVD) and PVD to LED chip manufacturers. Its patterned sapphire substrate (PSS) etcher has captured over 80% market share in China in the past four years. Its overall market share in the three product lines is over 70%, with the remaining supply coming from Oxford Instrument and Evatec.
Exhibit 90. LED manufacturing process
Front end Middle end Back end
LED dies on Sapphire/SiC/Si/ Cleaning Substrate wafer GaAs PVD (ITO) Die singulation MOCVD Mask/lithography Test
Epitaxy wafer Cleaning Inspection
LED chips on GaN Etch wafer LED structure Packaging Anneal Encapsulati SiO2 Etch on (PECVD) Packaged Grinding LED
Source: Company data, HSBC Qianhai Securities
Its key customers include leading Chinese LED chip makers such as San’An Optoelectronics, HC Semitek, Sinopatt, Elec-Tech International, and Changelight. Chinese LED makers are gaining market share by expanding capacity and raising capex. The fixed asset investment of the top four LED chip makers surged 155% y-o-y in 2017 to RMB7bn. The rapid capacity expansion last year was mainly due to undersupply and strong demand.
LED Inside, an industry media platform, forecasts that China’s total LED chip production capacity will increase by 49% y-o-y, from 8.56m pieces (2-inch equivalent) in 2017 to 12.76m pieces in 2018. This growth is in line with our 45% y-o-y revenue growth forecast for Naura in 2018.
Although the top Chinese LED chip makers are aggressively expanding capacity, lower-tier Chinese and overseas vendors are more conservative due to the lack of cost advantage and scale effect. Therefore, we believe China will continue to increase their market share in LED capacity in 2018-20 from the 58% level in 2017. This will benefit Chinese LED equipment vendors such as Naura.
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Exhibit 91. Major LED chip makers’ Exhibit 92. Capacity expansion plans of capex trend LED makers in China 8,000 4,500 (RMBm) ('000 pieces/month, 2 inch) 4,000 7,000 4,000 3,760 3,500 6,000 3,160 3,000 3,000 5,000 2,930 2,500 2,700 4,000 2,000 2,000 3,000 1,700 1,500 1,400 2,000 1,000 1,000 1,000 700 500 - - 170 2009 2010 2011 2012 2013 2014 2015 2016 2017 2016 2017 2018e San'An HC Semitek Changelight Aucksun San'An HC Semitek Aucksun Others Source: Company data, HSBC Qianhai Securities Source: LEDInside
On the demand side, we believe lighting, digital display and automotive will continue to be the key drivers in 2018-19. LEDInside forecasts that the LED packaging market will increase from RMB65.9bn in 2017 to RMB76.8bn in 2021, a 4% CAGR. In the longer term, mini LED and micro LED will become the new growth drivers for the LED market as they require more advanced knowledge and new technology. An upgrade cycle for equipment is likely to take place in the coming years, creating new opportunities for equipment makers.
The size of mini LED and micro LED is much smaller than LED, providing lower latency, higher contrast ratio and greater colour saturation. LEDInside forecasts that the mini LED and micro LED markets will reach a combined USD1.38bn in 2022 and USD2.89bn in 2025. Micro AR projector, head-up display (HUD), and large-size display panels are likely to be the applications for the new technologies. Nichia, a Japanese company, already announced it will mass produce mini LED by end 2018 and micro LED in 2022. San’An has also formed a strategic partnership with Samsung for micro LED supply.
Exhibit 93. Mini LED and Micro LED market Exhibit 94. Technical features of Mini and size Micro LED 1,600 (USDm) Mini LED Micro LED 1,400 Application LCD backlight, Organic light emitting display 1,200 short range display Micro projection display 1,000 Quantities to be Thousands Millions used in TV 800 Time of 2018 2019-2022 600 commercial launch 400 Advantages Curve and abnormity High power efficiency, 200 display higher contrast ratio Price compared 20% higher 3 times at initial stage - to LCD 2018 2019 2020 2021 2022
Mini LED Micro LED Source: LEDInside Source: LEDInside
Flat panel display: increasing exposure to BOE Naura’s flat panel display equipment includes ultraviolet curing, indexer, and cleaning tools, which are mainly applied in BOE’s thin film transistor-liquid crystal display (TFT-LCD) fabs, (G10.5, G8.5, G6, G5.5, and G4.5). Its ultraviolet cure is used to cure and dry a glue in the frame using ultraviolet light. An indexer mainly facilitates glass substrate movement and transportation along production lines. Naura also provides other equipment for display
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customers, including units for air cooling, solvent recycling, thermal recycling, and gas measuring controls.
Naura’s revenue from BOE has increased from RMB35m in 2015, RMB86m in 2016 to RMB130m in 2017. But its products only account for 1.0-1.5% of BOE’s total production line spending, suggesting ample opportunities to gain market share ahead.
Looking ahead, we identify the capacity ramp-up of BOE’s G10.5 fab in Hefei, G8.5 in Fuzhou, and upcoming new G10.5 fab in Wuhan as the key revenue drivers for Naura in 2018-20. The Hefei fab commenced commercial production in March 2018 and its designed capacity amounts to 120,000 sheets/month. BOE has budgeted RMB46bn to build the Wuhan TFT-LCD fab and construction started in March 2018. The construction period lasts two years and the project targets the 65/75 inch TV market.
Exhibit 95. Production capacity of BOE Location Fab/Gen Product Tech Capacity Capex Status ('000/month) (RMBbn) Beijing G5 LCD a-Si 70 11.0 In operation Ordos G5.5 LCD/OLED LTPS/OLED 30 22.0 In operation Hefei G6 LCD a-Si 120 17.5 In operation Beijing G8.5 LCD a-Si 150 28.0 In operation Hefei G8.5 LCD a-Si 120 28.5 In operation Chongqing G8.5 LCD a-Si 150 32.8 In operation Fuzhou G8.5 LCD a-Si 150 30.0 In operation Hefei G10.5 LCD a-Si 120 40.0 In operation Chengdu G6 AMOLED OLED 48 46.5 In operation Wuhan G10.6 LCD a-Si 120 46.0 Construction Mianyang G6 AMOLED OLED 48 46.5 Construction
Source: Company data
Vacuum equipment: resilient growth outlook despite near-term headwind The products in this segment include crystal growing, brazing, heat treatment and sintering furnaces. Naura is a major supplier of vacuum equipment to mono-crystalline wafer maker Longi Green Energy. Longi has increased its wafer manufacturing capacity from 5GW in 2015, to 7.5GW in 2016 and 15.0GW in 2017, and plans to reach 28GW in 2018 and 45GW in 2020. Naura accounts for 50% of Longi’s vacuum equipment purchases (Dalian Liancheng is the other supplier).
Although China’s solar market installation may decline y-o-y in 2018 due to changes in subsidy policy announced in May, we believe the following factors will enable Naura to deliver stable revenue growth in vacuum equipment:
Installation growth overseas to offset China’s slowdown: IHS forecasts that global PV installation will grow 11% y-o-y in 2018 to 105GW despite downward revisions to China’s estimates from 53GW to 38GW. Countries such as Australia, Mexico, Canada, and Brazil are the growth drivers.
Market share gains of mono-crystalline over multi-crystalline: Mono-crystalline silicon wafer has a higher power conversion efficiency than multi-crystalline silicon and its production cost has declined rapidly in recent years, thanks to the adoption of diamond wire cutting and efficiency gains through technology innovation.
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Naura’s current order backlog with Longi is around RMB1bn, mainly for ingot capacity expansion projects in Ningxia and Yunnan. Naura expects to recognise RMB500m of this revenue in 2018.
Exhibit 96. Longi capacity expansion plan Exhibit 97. Market share breakdown of mono- and multi-crystalline wafer 50 100% (GW) 45.0 45 90% 40 36.0 80% 35 70% 30 28.0 60% 25 50% 20 40% 15.0 15 13.0 30% 8.0 9.0 10 7.5 7.5 20% 5 2.5 10% 0 0% 2016 2017 2018e 2019e 2020e 2017 2018 2020 2022 2025 2028 Mono wafer installed capacity Incremental capacity P-type multi P-type mono N-type mono
Source: Company data Source: ITRPV, HSBC Qianhai Securities
Exhibit 98. Contracts with Longi
Contract size Date Project (RMBm) Sep-17 Yunnan Ingot capacity expansion 344 Jun-17 Yunnan Ingot capacity expansion 345 Mar-17 Ningxia Zhongning ingot capacity expansion 168 Mar-17 Ningxia Yinchuan ingot capacity expansion 165 Jul-16 Ningxia Yinchuan ingot capacity expansion 161 Total 1,183
Source: Company data
Precision components: steady and sustainable growth High precision electronic components are Naura’s traditional business. Its products include precision resistors, microwave modules, tantalum capacitors, crystal devices, and power supply modules used in aerospace, aviation, shipping, and railways. Its customers are mainly in the defence industry and include China Aerospace Science and Technology Corporation, China Aerospace Science & Industry Corporation, and China North Industries Group.
Naura has limited competition in this business and enjoys premium margins. The segment’s revenue has increased steadily from RMB192m in 2010 to RMB763m in 2017, a 31% CAGR. Meanwhile, gross margin has consistently stayed above 40%. Looking ahead, Naura expects a 10-15% revenue CAGR in the coming 3-5 years, thanks to increases in defence spending, product upgrades, import substitution, and R&D initiatives in new applications.
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Exhibit 99. Revenue and growth trends of Exhibit 100. Gross profit and margin of the the precision components business precision components business 900 60% 400 70% (RMBm) (RMBm) 800 763 350 334 60% 50% 58% 59% 59% 700 56% 300 608 40% 271 50% 600 48% 250 44% 235 45% 44% 41% 500 30% 40% 204 40% 400 200 186 400 349 20% 157 30% 317 280 150 300 242 116 10% 20% 174 192 100 200 169 70 75 78 0% 10% 100 50
0 -10% 0 0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Revenue Yoy Gross profit Gross margin Source: Company data Source: Company data
Forecasts and valuation
Earnings forecasts We forecast that Naura will record a 52% net profit CAGR over 2017-20e, driven by a 27% revenue CAGR, gross margin expansion and operating leverage. We expect IC equipment will be the major revenue driver, with a 46% CAGR, followed by 37% in display and 35% in vacuum equipment. We believe IC equipment will account for 27% of total revenue by 2020, up from 18% in 2017. The company guides for RMB3.2bn revenue for 2018, which is supported by a robust order backlog. As at end-2017, Naura had an order backlog of over RMB2bn and received an additional RMB500-600m in new orders in 1Q18.
IC equipment has a gross margin of over 40%, vs. over 30% for LED and over 20% for solar equipment. With a higher revenue contribution from high-margin IC equipment, we expect the overall gross margin to increase from 36.6% in 2017 to 38% in 2020e. As its revenue increases, we believe Naura can deliver operating leverage in the coming years.
We now analyse the impact of government subsidies on net profit. Naura’s SG&A expenses surged from RMB203m in 2015 (before the acquisition of North Microelectronics) to RMB904m in 2016 but declined to RMB795m last year. This volatility is mainly due to the booking of R&D expenses. The government provides annual subsidies to Naura to support R&D for advanced IC equipment as part of the “02 Project”. The subsidies are reflected in the deferred income balance in non-current liabilities.
At the end of 2017, Naura had RMB1.25bn in deferred income on its balance sheet. Naura indicates that the government subsidy will continue at the level of RMB500-600m over 2018-20. We note that Naura’s annual subsidy income recognised on the income statement is largely in line with the R&D expenses booked. Therefore, we believe the fluctuation in R&D expenses and subsidies is neutral to our net profit forecast for Naura.
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Exhibit 101. Revenue and gross profit forecasts
2017-20 Revenue (RMBm) 2016 2017 2018e 2019e 2020e CAGR IC 300 400 552 828 1,242 46% LED 336 504 731 877 1,052 28% Solar 91 100 100 100 100 0% Display 86 130 182 246 332 37% Semiconductor equipment 813 1,134 1,565 2,051 2,726 34% Vacuum 88 201 500 500 500 35% Lithium battery 96 100 160 176 194 25% Precision component 608 763 862 992 1,140 14% Others 18 25 28 30 33 10% Total 1,622 2,223 3,114 3,748 4,593 27% y-o-y 37% 40% 20% 23% -15% Gross profit Semiconductor equipment 332 401 553 759 1,063 38% Vacuum 20 56 130 130 130 32% Lithium battery 19 19 30 33 37 25% Precision component 271 334 388 446 513 15% Others 3 3 4 4 4 13% Total 645 813 1,105 1,372 1,747 29% Gross margin Semiconductor equipment 40.9% 35.4% 35.4% 37.0% 39.0% Vacuum 22.7% 28.0% 26.0% 26.0% 26.0% Lithium battery 19.6% 19.2% 19.0% 19.0% 19.0% Precision component 44.6% 43.7% 45.0% 45.0% 45.0% Others 14.7% 13.1% 13.1% 13.1% 13.1% Total 39.7% 36.6% 35.5% 36.6% 38.0% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 102. Key assumptions in income statement (RMBm) 2015 2016 2017 2018e 2019e 2020e G&A expenses 203 904 795 1,061 1,107 1,166 R&D expenses booked 41 585 357 500 500 500 R&D investment capitalized 207 173 380 250 250 250 Total R&D investment 248 758 736 750 750 750 G&A to revenue excl. R&D 19.0% 19.7% 19.7% 18.0% 16.2% 14.5% Government subsidies booked 51 612 388 500 500 500 Deferred income balance 1,117 1,410 1,246 1,246 1,246 1,246
Source: Company data, HSBC Qianhai Securities estimates
Sensitivity analysis We think the revenue from the vacuum segment and IC equipment revenue growth are the two critical swing factors for earnings. Our earnings sensitivity analysis for 2018e shows that for every RMB200m difference in revenue from the vacuum segment, earnings would change by 1.2%; for every 5% difference in IC equipment revenue growth, earnings change by 0.6%, on our estimates. Exhibit 103. Sensitivity analysis for 2018e earnings ______Vacuum revenue (RMBm) ______100 300 500 700 900 28% 164 166 168 170 172 33% 165 167 169 171 173 IC equipment revenue growth 38% 166 168 170 172 174 43% 168 170 172 174 176 48% 169 171 173 175 177 Source: HSBC Qianhai Securities estimates
Balance sheet and cash flow Naura had RMB65m in net cash as at the end of 2017. Except for 2015, Naura has consistently registered a net cash position since listing. Its operating cash flow turned positive in 2017 and we expect this to continue thanks to an improving margin and working capital cycle.
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We expect 2018-20 capex to be comparable to 2017. The company has already started work on expanding its new manufacturing facility (phase 2 of the Beijing Yizhuang Economic and Technology Development Zone). The gross floor area of phase 1 is 40,000 square metres and phase 2 is much larger at 140,000 sqm. This will enable Naura to operate China’s largest IC equipment manufacturing base. Accordingly, we expect Naura to be cash flow positive in 2020. The company has maintained a 10% cash dividend pay-out ratio since 2016.
Exhibit 104. Balance sheet statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Cash and equivalents 263 213 229 964 1,020 894 871 922 Net receivables 613 608 675 989 1,210 1,536 1,849 2,265 Inventory/stocks 615 566 593 1,178 2,033 2,752 3,255 3,898 Other current assets 85 79 73 215 198 198 198 198 Total Current assets 1,576 1,466 1,570 3,346 4,461 5,380 6,172 7,283
Net PP&E/Fixed assets 552 621 1,007 1,383 1,449 1,550 1,643 1,729 Net intangibles 511 687 1,095 1,061 1,027 982 983 978 Total investments 2 ------Other long-term assets 1,105 1,112 508 751 1,209 1,209 1,209 1,209 Total non-current asset 2,170 2,420 2,610 3,195 3,685 3,740 3,835 3,915 Total assets 3,746 3,886 4,180 6,541 8,145 9,120 10,007 11,198
Accounts payable 422 481 533 865 1,333 1,982 2,344 2,807 Short-term debt and 117 195 339 437 520 520 520 520 current portion of long- term debt Other current liabilities 188 126 163 404 1,130 1,339 1,610 1,939 Current liabilities 727 801 1,035 1,707 2,984 3,841 4,473 5,266
Long-term debt - - - 60 436 400 400 400 Other long-term 1,093 1,121 1,117 1,410 1,246 1,246 1,246 1,246 liabilities/creditors Total long-term liabilities 1,093 1,121 1,117 1,470 1,681 1,646 1,646 1,646 Total liabilities 1,820 1,922 2,153 3,177 4,665 5,486 6,119 6,911
Common stock 352 352 352 458 458 458 458 458 Treasury stock ------Reserve 1,472 1,479 1,518 2,735 2,850 3,004 3,258 3,657 Other common equity (0) (0) (1) (1) (1) (1) (1) (1) Total common equity 1,824 1,831 1,869 3,192 3,308 3,461 3,715 4,114 Minority interest 102 133 158 172 173 173 173 173 Total equity 1,926 1,964 2,027 3,364 3,480 3,634 3,888 4,287 Total liabilities and equity 3,746 3,886 4,180 6,541 8,145 9,120 10,007 11,198 Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 105. Cash flow statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Net income 103 42 39 93 126 170 282 443 Minority interest and 37 70 68 81 73 57 94 147 impairment add-back Depreciation and 43 67 82 192 198 221 236 250 amortization add-back Investment Loss - (0) ------(Increase)/decrease in (219) (100) (245) (587) (389) (397) (453) (597) working capital : Other operating cash flow 10 15 13 20 24 - - - items Cash flow from (26) 93 (44) (201) 32 51 159 243 operations
Capital expenditure (166) (196) (67) (178) (232) (230) (230) (230) (Acquisitions)/divestitures 3 0 0 1 0 - - - Investments (2) 2 ------Other investment cash ------flow items Cash flow from investing (164) (194) (67) (178) (232) (230) (230) (230)
Dividends paid (45) (27) (19) (49) (62) (48) (51) (63) Share repurchase/issue - - 0 917 - - - - Increase/(decrease) in (90) 78 144 99 332 100 100 100 debt Other financing cash flow (0) - - - (6) - - - items Cash flow from financing (135) 51 125 967 264 52 49 37 Effect of foreign (0) 0 0 0 (1) - - - exchange rate changes Total cash flow (326) (50) 15 588 63 (126) (23) 50 Free cash flow (192) (103) (111) (380) (201) (179) (71) 13 Source: Company data, HSBC Qianhai Securities estimates
Valuation We apply a 12m forward price-to-sales (P/S) methodology to value Naura, rather than PE, for two key reasons. 1) First, Naura’s earnings performance is volatile and largely depends on the government subsidy. The company is now trading at a high forward PE multiple of 100x, in line with the mid-cycle 98x but much higher than the industry average. That said, despite the bumpy earnings trend, we think investors are still willing to apply a valuation premium to Naura. This is not because of the near-term earnings performance, but due to its long-term growth outlook and its strategic importance in semiconductor equipment. 2) And second, Naura is still at the early stage of gaining traction with foundry customers and offers ample revenue growth potential, in our view.
We forecast accelerated revenue growth – 52% CAGR in 2017-20e, up from 6% in 2010-17. The stock is trading at 6.8x forward P/S, in line with the shares’ historical mid-cycle average of 6.3x. In light of Naura’s faster revenue growth outlook, we think it is reasonable to apply one standard deviation above the mid-cycle, hence a target P/S multiple of 8.4x, to set the target price. This equals RMB63.97, implying 20% upside.
Downside risks Advanced IC equipment: Naura can produce 28nm and above IC equipment for foundries. Failure to improve technical know-how and mass produce more advanced nodes may reduce future growth opportunities.
Solar: The solar industry is highly dependent on government subsidy policies, so changes in policy may affect order flows. As most of Naura’s vacuum products are sold to Longi, any change in the customer’s sourcing strategy and operational performance may affect Naura.
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Government subsidy and income recognition. Naura’s earnings are sensitive to government subsidies. Policy changes would create uncertainty about the company’s earnings.
Exhibit 106. Historical 12m forward P/S Exhibit 107. Historical 12m forward PE 20.00 400.0
18.00 350.0 16.00 300.0 14.00 250.0 12.00
10.00 200.0 +1 STD +1 STD 8.00 150.0 6.00 Mean Mean 100.0 4.00 -1 STD 50.0 -1 STD 2.00
- 0.0
2010/9 2017/9 2010/3 2011/3 2011/9 2012/3 2012/9 2013/3 2013/9 2014/3 2014/9 2015/3 2015/9 2016/3 2016/9 2017/3 2018/3
2012/3 2015/9 2010/9 2011/3 2011/9 2012/9 2013/3 2013/9 2014/3 2014/9 2015/3 2016/3 2016/9 2017/3 2017/9 2018/3 2010/3 Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
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Financials & valuation: Naura Technology Group Co Buy
Financial statements Valuation data Year to 12/2017a 12/2018e 12/2019e 12/2020e Year to 12/2017a 12/2018e 12/2019e 12/2020e Profit & loss summary (CNYm) EV/sales 10.9 7.8 6.5 5.3 Revenue 2,223 3,114 3,748 4,593 EV/EBITDA 582.6 693.0 104.9 47.8 EBITDA 42 35 233 510 EV/IC 7.1 6.7 6.2 5.7 Depreciation & amortisation -198 -221 -236 -250 PE* 194.2 143.2 86.3 55.1 Operating profit/EBIT -157 -186 -3 260 PB 7.4 7.0 6.6 5.9 Net interest -27 -35 -34 -34 FCF yield (%) -2.6 -2.8 -2.3 -2.0 PBT 206 279 463 726 Dividend yield (%) 0.1 0.1 0.1 0.2 HSBC Qianhai PBT 206 279 463 726 * Based on HSBC Qianhai EPS (diluted) Taxation -38 -52 -86 -136 Net profit 126 170 282 443 HSBC Qianhai net profit 126 170 282 443 Issuer information Cash flow summary (CNYm) Share price (CNY) 53.26 Free float 78% Cash flow from operations 32 51 159 243 Target price (CNY) 63.97 Sector Electronic Equipment Capex -232 -230 -230 -230 Reuters (Equity) 002371.SZ Country China Cash flow from investment -232 -230 -230 -230 Bloomberg (Equity) 002371 CH Analyst Frank He Dividends -13 -17 -28 -44 Change in net debt 402 91 23 -50 Market cap (USDm) 3,576 Contact +86 755 8898 3136
FCF equity -645 -679 -571 -487 Balance sheet summary (CNYm) ESG metrics Intangible fixed assets 1,027 982 983 978 Tangible fixed assets 2,657 2,758 2,851 2,937 Environmental Indicators Governance Indicators Current assets 4,461 5,380 6,172 7,283 GHG Intensity (kg/USD) na No. of board members 12 Cash & others 1,020 894 871 922 Energy Intensity (kWh/USD) na Average board experience (years) 2.9 Total assets 8,145 9,120 10,007 11,198 CO2 reduction policy Yes Female board members (%) 16.7 Operating liabilities 3,709 4,566 5,199 5,991 Social Indicators Board members Independence (%) 33.3 Gross debt 956 920 920 920 Net debt -65 26 49 -2 Employee costs as % of sales na Shareholders' funds 3,308 3,461 3,715 4,114 Employee turnover (%) na Invested capital 3,416 3,660 3,937 4,285 Diversity policy Yes Source: Company data, HSBC Qianhai Securities
Ratio, growth and per share analysis Year to 12/2017a 12/2018e 12/2019e 12/2020e Price relative Y-o-y % change Revenue 37.0 40.1 20.4 22.5 64.00 64.00 EBITDA -15.6 561.4 118.8 54.00 54.00 Operating profit PBT 18.2 35.6 65.8 56.8 44.00 44.00 HSBC Qianhai EPS 24.6 35.6 65.8 56.8 Ratios (%) 34.00 34.00 Revenue/IC (x) 0.7 0.9 1.0 1.1 24.00 24.00 ROIC -1.8 -2.2 2.1 7.2 ROE 3.9 5.0 7.9 11.3 14.00 14.00 ROA 2.6 3.0 4.2 5.8 2016 2017 2018 EBITDA margin 1.9 1.1 6.2 11.1 Naura Technology Group Co Rel to CSI 300 Index Operating profit margin -7.0 -6.0 -0.1 5.7 Source: HSBC Qianhai Securities EBITDA/net interest (x) 1.6 1.0 6.8 14.8 Net debt/equity -1.9 0.7 1.3 0.0 Note: Priced at close of 03 Sep 2018 Net debt/EBITDA (x) -1.5 0.7 0.2 0.0 CF from operations/net debt 196.8 325.7 Per share data (CNY) EPS Rep (diluted) 0.27 0.37 0.62 0.97 HSBC Qianhai EPS (diluted) 0.27 0.37 0.62 0.97 DPS 0.03 0.04 0.06 0.10 Book value 7.22 7.56 8.11 8.98
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Han’s Laser (002008 CH)
Multiple revenue growth drivers with a diversified customer base Margin upside on growing in-house laser manufacturing Initiate with a Buy rating and target price of RMB50.59
Riding on the smart manufacturing trend
Han’s Laser, established in 1996, provides laser, robotics and automation equipment and system solutions in smart precision manufacturing industries in China. Its product portfolio includes laser labelling/cutting/welding equipment, PCB/LED/semiconductor special equipment, robots, automation equipment and system solutions. The products are mainly used in metal or non-metal processing of consumer electronics, automobiles, shipbuilding, aerospace, rail transportation, electrical vehicle (EV) batteries, PCB, appliance industries. Its key customers include Apple, Samsung, BOE, Yutong Bus, and Shennan Circuits. The company was listed on the Shenzhen Stock Exchange in 2004.
In the last 30 year Han’s Laser has moved steadily up the value chain after starting as a manufacturer of low-power laser equipment. It now serves dozens of industries and is the market share leader in laser processing equipment in China. Over 2004-17, it achieved a 29% revenue CAGR and 32% net profit CAGR.
Exhibit 108. Corporate milestones Year Events 1996 Develops and manufactures low-power laser labelling equipment 2000 Extends downstream application from traditional leather, garment, electronics to other industries like jewellery, home appliances 2004 Listed on Shenzhen Stock Exchange; starts low-power laser cutting/welding equipment and platemaking printing equipment business 2005 Starts PCB equipment business 2009 Starts LED and solar equipment business; become a supplier to Apple with 70% laser equipment allocation in 2017 2010 Starts high-power laser equipment business 2012 Changes strategy to focus on laser processing business and large customers, starts to spin off non-core businesses like solar, platemaking printing equipment business 2014 Starts robotics business in a bid to provide integrated automation solutions to customers; low-power laser equipment market extends to display panel, EV battery industries 2015 Starts in-house supply of part of low-power laser and picosecond laser source; high-power laser equipment market extends to auto, aviation, shipping industries 2017 Starts semiconductor equipment business through acquisition of Fortrend Engineering Source: Company data, HSBC Qianhai Securities
The core business can be separated into laser processing equipment and industry special equipment. Laser processing equipment, representing 81% of revenue in 2017, can be further categorized as low-power and high-power. Low-power laser equipment revenue streams are generated from equipment orders by Apple, the EV battery industry, and the display panel industry. Special equipment covers PCB, LED manufacturing and the company aims to gain more exposure in the semiconductor industry.
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Exhibit 109. Historical revenue/net profit Exhibit 110. Revenue breakdown in 2017 14,000 1,800 (Rmb m) 1,600 12,000 Others 1,400 4% 10,000 LED 1,200 Equipment Display panel 5% 8,000 1,000 4% PCB Low-power Apple 6,000 800 equipment 35% 10% laser EV 600 equipment Others battery 4,000 High-power laser 63% 400 equipment 19% 5% 2,000 18% 200
- - 2013 2014 2015 2016 2017 Low-power equipment High-power equipment PCB equipment LED Equipment
Laser printing equipment Others Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Historical gross profit margin and operating profit margins are about 40% and 12% respectively. Margin expansion in 2017 was driven by high-margin Apple business and enhanced operating efficiency. The gross profit margin of low-power laser equipment is higher than for high-power as the company makes some critical pieces of equipment, such as the laser source, in-house.
Exhibit 111. GPM trend by segment Exhibit 112. GPM and EBIT margin trend 50.0% 50.0%
45.0% 44.2% 45.0% 41.0% 41.3% 40.0% 39.2% 39.6% 44.1% 42.7% 37.9% 38.2% 36.2% 40.0% 40.3% 41.5% 35.0% 39.1% 38.8% 37.6% 30.0% 35.0% 36.3% 25.0%
31.4% 30.9% 31.5% 20.0% 30.0% 29.4% 15.0% 16.2% 28.5% 13.9% 13.0% 27.8% 11.3% 25.0% 10.0% 10.9% 10.1% 9.5% 8.0% 23.6% 22.5% 5.0% 20.0% 0.0% 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016 2017 Low-power equipment High-power equipment PCB equipment LED Equipment Gross margin EBIT margin
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Han’s Laser attaches great importance to R&D, and the ratio of R&D expense to revenue has consistently remained above 5% (it was 7.4% in 2017). The company has nearly 4,000 R&D staff, 32% of total employees, covering laser source, automation system integration, linear motor, visual recognition, software, and mechanical controls. By the end of 2017, the company had obtained 2,486 patents, nearly ten times more than ten years ago. We believe the high level of R&D investment will help the company improve its competitiveness and maintain its market leader position in the long run.
Laser industry overview Light is passed through a lens to form a laser beam with extremely high energy density. The material (including metal and non-metal) is cut, welded, surface treated, and punched using the characteristics of interaction between the laser beam and the material.
Compared to traditional methods, laser processing has advantages such as no contact process, and high positioning accuracy; it’s also quiet and clean. Laser technology plays an increasingly important role in improving product quality, labour productivity, automation, reducing pollution, and material consumption.
The laser industry supply chain is composed of laser material/component manufacturers, laser source manufacturers, and laser equipment manufacturers. Upstream are the optical materials,
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optical components, mechanical and numerical control components. Optical materials include laser crystal material, and special optical fiber. Optical components include laser optics, galvanometers, modulators, and laser processing heads; others include mechanical, numerical control, and power supply equipment.
The laser source is the critical part of laser equipment. By power, the laser source can be categorised as low-power (<1.5KW) and high power (>1.5KW). By pump energy source, they can be classified into CO2, YAG, fiber, and semiconductor lasers. The laser source can also be divided into continuous laser and pulsed laser. According to pulse width, the pulsed laser can be further divided into millisecond, microsecond, nanosecond, picosecond, and femtosecond lasers.
Mid-stream laser equipment that can be used in multiple downstream industries such as machinery, automobiles, aerospace, steel, shipbuilding, electronics and military.
Exhibit 113. Laser equipment supply chain Optical Numerical Servo motor Auxiliary gas component control system
Up-stream core components Laser source
CO2 laser Solid-state Fiber laser Other laser source laser source source sources
Mid-stream Laser Laser cutting Laser labeling Laser welding equipment communication
Down-stream industries Military Mechanical Electronics Automobile Aviation Metallurgy Telecom
Source: HSBC Qianhai Securities
China is the hot spot According to Optech Consulting, the global market for laser systems for materials processing reached USD12.6bn in 2016, a 5% CAGR since 2006. As the world’s factory, China is the main laser system market. China is also the main growth contributor thanks to macroeconomic development, manufacturing upgrades, and policy support.
According to laser.ofweek.com, a professional laser industry portal, the sale of laser system (including imports) in China for the industry manufacturing, communication, medical and scientific research was RMB42.2bn in 2016, a 23% CAGR since 2010. Of this, the laser systems for materials processing is an important segment with a market of about RMB25bn in 2015.
According to Optech Consulting, the high-power (>1.5kW) laser system, mainly used in the automobile, shipbuilding and machinery industries, represents 75% of the market. The remaining 25% is for low-power (<1.5kW), mainly used in the microelectronics, semiconductor and display industries.
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Exhibit 114. Global laser system market size Exhibit 115. China laser system market size
14.0 45.0 42.2 (USDbn) 12.6 (RMB bn) 5% CAGR 11.8 11.8 40.0 38.5 12.0 34.5 10.7 35.0 10.0 10.2 10.0 9.4 23% CAGR 30.0 8.7 26.0 7.7 7.9 8.0 25.0 19.5 20.0 16.9 6.0 5.2 15.0 11.7 9.7 4.0 10.0
2.0 5.0 0.0 0.0 2010 2011 2012 2013 2014 2015 2016 2017 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Optech Consulting, HSBC Qianhai Securities Source: Ofweek, HSBC Qianhai Securities
Lowering costs to stimulate demand The laser source is the core part of laser equipment. It accounts for 30-40% of the cost of low- power laser equipment, rising to nearly 60% for high power as only a few companies, including IPG, SPI, and Coherent, have the technological know-how.
Fiber laser, the third generation laser source noted for high efficiency levels and low maintenance costs, is gaining market share. The price has decreased 50% since 2012 as a result of a higher localization rate in China. We expect the cost will continue to fall as localization increases.
China high-power laser source producers are making technical breakthroughs. For instance, Wuhan Raycus developed the first 6kW fiber laser source in 2017. As costs fall and manufacturing upgrades continue, we believe laser equipment demand will remain robust. Moreover, the combination of laser equipment and automation is improving product quality, production efficiency and reducing labour costs. We think the system integration of laser and automation will become a mainstream trend.
Exhibit 116. Fiber laser source localization Exhibit 117. Fiber laser source price rate 100% 160 145 90% 89% (RMB 10000) 140 80% 72% 68% 120 70% 120 63% 103 60% 58% 100 90 50% 80 40% 42% 68 65 30% 60 27% 20% 17% 40 7% 10% 4% 1% 1% 20 10.5 12 0% 7.5 3.5 4.5 6.7 2013 2014 2015 2016 0 Low-power (<100W) Mid-power (100W-1.5kW) High-power (>1.5kW) 10W 20W 30W 500W 1000W 2000W 2012 2016
Source: Zhixun Consulting, HSBC Qianhai Securities Source: Zhixun Consulting, HSBC Qianhai Securities
Han’s Laser: market share In the global market, Trumpf is the market share leader in the laser processing industry with 30%, followed by Coherent, Han’s Laser, and IPG. As Han’s Laser’s 2017 sales exceeded RMB10bn, we estimate its global market share is now above 10%. Trumpf has over 50% gross margin because of its vertically-integrated business model (from laser source to integrated automation solutions). IPG also achieves a gross margin of over 50% by leveraging its nearly 70% market share in the high-power fiber laser source market.
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In China, Han’s Laser has a 35-45% market share in both the high-power and low power laser equipment markets. Compared with foreign players, Han’s Laser has advantages in term of product cost performance, customization capability, sales service network and close relationships with local clients. Trumpf, the global market leader, has a 25-35% market share in China behind Han’s Laser.
Besides Han’s, other well-known domestic laser equipment makers include GreatStar Industrial ( ), HG Tech ( ), Tianqi Laser ( ), He Laser ( ), Golden Laser ( ), and Delphi Laser ( ). At the low end of the market there are thousands of laser equipment makers which lack core technology.
Exhibit 118. Market share breakdown in 2016 Exhibit 119. Top players’ GPM comparison 60.0%
Others 55.0% 23%
Trumpf 50.0% 30%
Bystronic 45.0% 3% Prima Industrie 4% 40.0% Cymer Han's Laser 8% 7% Coherent (including 35.0% Rofin) Jenoptik 13% 6% IPG 6% 30.0% 2010 2011 2012 2013 2014 2015 2016 2017
Trumpf Han's Laser Coherent IPG
Source: Ofweek, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities
Low-power laser: new design of consumer electronics and new downstream industries Han’s Laser’s low-power equipment segment can be separated into IT, display panel, EV battery and others.
IT Han’s Laser’s key clients in IT industries are smartphone makers and their component suppliers. The main applications include laser labelling, drilling, cutting, and welding. Typical applications for smartphone exteriors include logo labelling, laser drilling, home key cutting, camera lens cutting, screen cutting, and LDS laser direct molding. Typical applications for smartphones include PCB/FPC laser cutting, labelling, middle frame drilling, welding, cutting, battery labelling, and conductive glass laser etching.
Apple is the single big client, accounting for 35% of total revenue or 55% of low-power laser equipment segment in 2017. New material, new appearance, utilization enhancement, better quality and environmental protection are the key reasons for smartphone makers to adopt laser processing. For instance, the latest iPhone X model includes several innovations, including an AMOLED full screen, double-side 2.5 glass + stainless steel middle frame, wireless charging, 3D face sensing, stereo effect, and waterproofing, which have driven demand for laser equipment.
Consumer electronics is another growth factor. For instance, using FPC design helps make devices smaller (laser cutting is needed for FPC manufacturing). Other processes such as picosecond/femtosecond lasers, small structure welding on middle metal frame, laser cleaning process to remove metal frame PVD coating, and waterproof testing equipment, will also drive the demand for laser equipment. In addition, with the increasing adoption of 2.5/3D glasses + metal middle frame in the 5G era, we see a potential market for laser equipment in the Android camp.
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Display panels Display panels are China’s fourth largest import by value after integrated circuits, oil and iron ore. Domestic substitute demand has been accelerating in recent years. Panel makers led by BOE began to increase their investment scale, and China’s TFT-LCD and AMOLED panel production capacity gradually increased. According to WitsView estimates, China officially surpassed South Korea to become the largest supply area for large-size panels in 2017, and the supply rate in mainland China will move toward 50% by 2020. According to our estimates, investment in panel production lines will exceed RMB400bn in the next two years.
Most of the laser equipment for new OLED lines in China is imported from South Korea and Japan. The penetration rate of domestically produced equipment is very low. In order to reduce costs, we expect the localization rate will gradually increase. Han’s Laser’s OLED equipment includes laser stripping equipment (LLO), flexible cutting machine, and laser repair equipment. The four production lines planned by BOE are currently being tested exclusively by Han’s Laser, and the management aims to start shipments in 2018.
Exhibit 120. Large-size LCD panel capacity Exhibit 121. BOE LCD+AMOLED capacity distribution by region area expansion 100.0% 60 50%
90.0% (milliom m2) 45% 50 80.0% 40% 70.0% 35% 40 60.0% 30% 50.0% 30 25% 40.0% 20% 20 30.0% 15% 10% 20.0% 10 10.0% 5% 0.0% 0 0% 2015 2016 2017e 2018e 2019e 2020e 2012 2013 2014 2015 2016 2017e 2018e 2019e Korea Taiwan China Japan US BOE Capacity Yoy Source: WitsView, HSBC Qianhai Securities Source: IHS, HSBC Qianhai Securities
EV battery According to the Ministry of Industry and Information Technology’s (MIIT) “Technology Roadmap for Energy Saving and New Energy Vehicles,” by 2025, new energy vehicles will account for more than 20% of total vehicle sales units. This will clearly drive the demand for EV batteries. MIIT said the total capacity of the battery industry will exceed 100Gwh by 2020, a 34% CAGR from 2017, implying that over RMB50bn of equipment investment is needed in the next three years. To improve the safety, reliability and lifespan of batteries, laser welding technology is becoming an industrial trend in battery production.
By setting up new energy business unit/subsidiaries, and external acquisitions, Han’s Laser is now able to produce equipment for the entire battery manufacturing process (cathode, anode, coating, laser welding, testing, injection, and packaging). Key clients include CATL, Guoxuan High-tech ( ), Lishen Battery ( ), China Aviation Lithium Battery ( ) and EVE Battery ( ). Given the scale of downstream capacity expansion plans, we expect the growth of the EV battery segment to remain robust.
PCB: benefits from production capacity relocation to China The global value of the PCB industry’s output is now USD60bn, accounting for more than a quarter of the total output value of the electronic components industry. Due to China’s huge domestic market, and the advantages of lower labour costs and better industrial support, more global PCB production capacity has shifted to China since 2000. In 2006, mainland China surpassed Japan to become the largest PCB manufacturer in the world.
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Exhibit 122. Global PCB market Exhibit 123. PCB production output by region 70 30% 100.0% (USDbn) 25% 90.0% 60 20% 80.0% 50 15% 70.0%
40 10% 60.0% 5% 50.0% 30 0% 40.0% 20 -5% 30.0% -10% 20.0% 10 -15% 10.0% 0 -20% 0.0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016 Global PCB market size Yoy China Japan Asia ex. China and Japan North America Europe Source: Prismark, HSBC Qianhai Securities Source: Prismark, HSBC Qianhai Securities
Han’s Laser has a full spectrum of PCB equipment, covering the entire manufacturing process, including exposure, mechanical/laser drilling, mechanical/laser molding, electrical measurement, and automatic optic inspection (AOI) testing. It is the first-tier supplier of local leading PCB producers such as SCC ( ), Suntak ( ), and Kinwong ( ). Meanwhile, the company is gaining recognition from foreign PCB producers such as WUS ( ), Tripod-tech ( ), and Zhen Ding Tech ( ).
Over the past 10 years, Han’s Laser PCB segment has registered a 20% revenue CAGR, higher than the industry average. We believe the PCB segment will continue to outperform, driven by production capacity expansion of local PCB producers. For example, SCC aims to increase capacity to 1.64m sqm by end of 2018, up from 1.30m sqm in 2017.
High-power laser – a blue sky market The high-power laser system market is emerging as an enhancement to traditional punching machines and resistance welding equipment. It is already being used in the automobile, aerospace and military industries, and other industrial applications. According to chyxx.com ( ), the traditional punching equipment market is worth about RMB20-30bn and traditional resistance welding equipment over RMB60bn. Although laser processing has various advantages, such as high accuracy/flexibility, short processing time and less processing consumables, it still at the early stage of development.
In 2017, nearly 90% of Han’s Laser high-power laser system revenue was generated from cutting equipment, and the rest from welding equipment. Downstream clients include SAIC, FAW, Yutong and Kinglong Bus from the automobile industry, and Xingguan ( ), Zhongnong Boyuan ( ), XCMG ( ) from agricultural machinery, and AVIC ( ) from aerospace. Looking ahead, we expect the company’s high-power segment to remain high growth based on the improving affordability of downstream clients and low penetration rate, particularly for local automobile OEMs.
The automobile industry is one of the largest markets for high-power laser welding equipment. According to chyxx.com ( ), China’s auto manufacturing equipment market is now worth over RMB150bn, of which welding equipment accounts for about 25%, so the addressable market for laser welding in the automobile industry alone is nearly RMB40bn. As the first mover, Trumpf is the market leader in the automobile industry, and while Han’s Laser is making progress the contribution to revenue is still minimal. In 2016, the company delivered laser welding integrated solutions for Audi, BMW and Mercedes Benz.
Besides heavy industry, high-power laser processing is starting to be used in consumer electronics such as the metal frame of smartphones. The metal material utilization rate of traditional CNC punching is about 80%, and it is about 95% for high-power laser processing. Han’s Laser has shipped a few samples to Apple for testing, and we expect this high-power project with Apple to materialise in 2019.
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Vertical integration to improve margin Given the importance of the laser source, in-house supply capability is critical for competiveness and margin improvement. In order to minimise the impact from IPG, the dominant fiber laser source supplier, Trumpf acquired SPI’s laser source business segment in 2008. Other equipment makers like Jenoptik and Coherent have also entered the fiber laser source market.
Han’s Laser has been putting great emphasis on laser source development. According to management, 50% of low-power fiber laser source is now made in-house, and high-power fiber laser source in-house supply will materialise in 2018. In 2016, Han’s Laser acquired Coractive High-Tech, a special fiber producer in Canada. The special fiber is a core component for producing fiber laser source. Recently, the company completed an RMB230m convertible bond issuance, of which RMB150m will be invested in high-power laser cutting and welding system projects. This suggests that the company is committed to closing the technology gap with IPG.
Entering the semiconductor industry by acquisition In 2016, Han’s Laser acquired an 80% stake in Fortrend Engineering, a leading supplier of solutions of bulk wafer transfer, standard mechanical interface (SMIF), ultra-cleaning automation, and wafer surface heat treatment in IC fabrication. Fortrend was established in the US in 1979, and has two manufacturing facilities in Xinzhu, Taiwan and Shenyang, China. Its client portfolio includes TSMC, Intel, UMC, Applied Materials, Micron and Tower. It provides wafer transport, wafer cure oven systems, and wafer sorter systems.
Fortrend recorded sales of nearly RMB200m in 2017, according to management. Han’s Laser aims to cross-sell its laser equipment and automation solution to Fortrend’s existing clients. We expect Han’s Laser to gain market share by gaining new customers such as SMIC and JCET.
Forecasts and valuation
Earnings forecasts We forecast a 36% net profit CAGR during 2018-20e, driven by a 32% revenue CAGR, margin expansion through vertical integration, as well as operating leverage.
We believe laser equipment will continue to be Han’s Laser’s revenue driver, with a 32% revenue CAGR (high-power equipment 45% CAGR, low-power equipment 27% CAGR). We expect PCB equipment to have a 30% revenue CAGR and semiconductor equipment to achieve a 70% revenue CAGR in 2018-20e, albeit from a low base. As a result, we expect laser equipment will account for 77% of total revenue in 2020e, down from 81% in 2017.
We expect the gross margin of high-power equipment will improve from 26% in 2017 to 30% in 2020e thanks to vertical integration for the laser source business. As the gross margin of high-power is still lower than other segments, the overall gross margin will fall slightly from 41.3% in 2017 to 40.1% in 2020e as the high-power segment expands. We expect the SG&A to revenue ratio to decline over time as the company is promoting automation in its manufacturing facilities.
Exhibit 124. Forecast of revenues from Apple RMBm 2016 2017 2018e 2019e 2020e CAGR 18-20e Labelling equipment 650 1,500 1,000 1,200 1,200 10% Welding equipment 300 1,500 1,000 1,500 1,500 22% Cutting equipment 300 500 500 800 800 26% Automation solution 350 500 500 500 500 0% High-power equipment 100 1500 1500 287% Total 1,600 4,000 3,100 5,500 5,500 33% Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 125. Revenue and profit forecast by segment RMBm 2014 2015 2016 2017 2018e 2019e 2020e CAGR 18-20e Revenue Laser equipment 3,769 3,847 5,149 9,319 10,099 14,951 17,660 32% Low-power equipment 2,915 2,917 3,690 7,245 7,303 9,946 11,779 27% High-power equipment 854 929 1,459 2,074 2,796 5,005 5,881 45% PCB equipment 589 707 890 1,210 1,816 2,360 3,068 30% LED Equipment 618 343 482 540 594 654 719 10% Semiconductor 400 720 1,152 70% Laser printing equipment 212 158 102 Others 378 533 336 490 305 320 336 5% Total 5,566 5,587 6,959 11,560 13,214 19,005 22,935 32% Gross profit Laser equipment 1,553 1,438 2,006 3,870 3,895 5,877 7,065 35% Low-power equipment 1,285 1,173 1,577 3,333 3,140 4,476 5,300 30% High-power equipment 268 265 429 539 755 1,401 1,764 53% PCB equipment 229 257 335 460 654 873 1,135 32% LED Equipment 146 95 152 184 203 223 245 10% Semiconductor 200 360 576 70% Laser printing equipment 38 14 4 Others 239 311 164 257 152 160 168 5% Total 2,204 2,115 2,661 4,771 5,104 7,493 9,189 34% Gross margin Laser equipment 41.2% 37.4% 39.0% 41.5% 38.6% 39.3% 40.0% Low-power equipment 44.1% 40.2% 42.7% 46.0% 43.0% 45.0% 45.0% High-power equipment 31.4% 28.5% 29.4% 26.0% 27.0% 28.0% 30.0% PCB equipment 38.8% 36.3% 37.6% 38.0% 36.0% 37.0% 37.0% LED Equipment 23.6% 27.8% 31.5% 34.1% 34.1% 34.1% 34.1% Semiconductor 50.0% 50.0% 50.0% Laser printing equipment 17.8% 8.9% 3.6% Others 63.3% 58.4% 48.9% 52.5% 50.0% 50.0% 50.0% Total 39.6% 37.9% 38.2% 41.3% 38.6% 39.4% 40.1% Source: Company data, HSBC Qianhai Securities estimates
Sensitivity analysis We think low-power laser equipment revenue from Apple and high-power laser equipment revenue growth are the two critical swing factors for earnings. Our earnings sensitivity analysis for 2018e shows that for every RMB500m difference in low-power laser equipment revenue from Apple, earnings would change by 4.9%; for every 10% difference in high-power laser equipment revenue growth, earnings would change by 0.4%, on our estimates.
Exhibit 126. Sensitivity analysis for 2018e earnings ______Low-power laser equipment revenue from Apple (RMBm) ______2,000 2,500 3,000 3,500 4,000 16% 1,762 1,849 1,936 2,024 2,111 26% 1,769 1,857 1,944 2,031 2,118 High-power laser equipment 36% 1,777 1,864 1,951 2,038 2,125 revenue growth 46% 1,784 1,871 1,958 2,045 2,133 56% 1,791 1,878 1,966 2,053 2,140 Source: HSBC Qianhai Securities estimates
Balance sheet and cash flow Han’s Laser had net cash of RMB151m at the end of 2017. The company’s operating cash flow has largely met its capex needs over the past few years. We expect the company’s free cash flow to increase from RMB984m in 2017 to RMB2.8bn in 2020e, driven by strong earnings growth and flat capex. Han’s Laser is building a new production facility which it is describing as its “Global laser smart manufacturing base” in Shenzhen’s Baoan district. Capex planned is RMB2bn and the project is scheduled to be completed in 2019. After completion, Han’s Laser’s production capacity will increase by 200% to meet its capacity needs before 2022. On dividend policy, Han’s Laser maintained its cash dividend at RMB0.20/share over 2011-17, and we believe there is upside potential, in line with the growth in free cash flow.
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Exhibit 127. Balance sheet statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Cash and equivalents 797 1,018 696 846 2,325 5,111 5,730 7,959 Net receivables 1,638 1,924 2,086 2,754 4,084 4,706 6,769 8,169 Inventory/stocks 1,619 1,442 1,697 1,845 2,290 2,666 3,785 4,519 Other current assets 53 271 117 122 194 213 234 258 Total Current assets 4,107 4,656 4,596 5,567 8,894 12,697 16,518 20,905
Net PP&E/Fixed assets 1,267 1,268 1,305 1,543 1,371 2,120 2,819 3,004 Net intangibles 188 189 193 814 752 810 874 944 Total investments 724 628 816 1,453 1,672 1,672 1,672 1,672 Other long-term assets 352 455 672 993 1,415 1,497 1,455 1,398 Total non-current asset 2,531 2,540 2,987 4,803 5,209 6,098 6,819 7,018 Total assets 6,638 7,196 7,582 10,370 14,103 18,795 23,337 27,923
Accounts payable 1,275 1,476 1,738 2,825 3,785 4,444 6,308 7,532 Short-term debt and 1,026 978 299 1,282 1,833 1,833 1,833 1,833 current portion of long- term debt Other current liabilities 156 207 219 294 545 545 545 545 Current liabilities 2,457 2,660 2,256 4,401 6,163 6,822 8,686 9,910
Long-term debt 187 80 246 193 341 2,641 2,841 3,041 Other long-term 105 136 169 227 315 315 315 315 liabilities/creditors Total long-term liabilities 292 216 415 421 656 2,956 3,156 3,356 Total liabilities 2,749 2,876 2,670 4,821 6,819 9,778 11,842 13,267
Common stock 1,052 1,056 1,063 1,067 1,067 1,067 1,067 1,067 Treasury stock ------Reserve 2,536 3,069 3,677 4,239 5,914 7,648 10,126 13,287 Other common equity (9) ------Total common equity 3,579 4,125 4,740 5,306 6,981 8,715 11,193 14,354 Minority interest 309 195 172 242 302 302 302 302 Total equity 3,888 4,320 4,912 5,548 7,284 9,017 11,495 14,657 Total liabilities and equity 6,638 7,196 7,582 10,370 14,103 18,795 23,337 27,923 Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 128. Cash flow statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Net income 549 708 747 754 1,665 1,947 2,770 3,577 Minority interest and 41 53 57 88 156 150 150 150 impairment add-back Depreciation and 119 131 131 149 169 190 244 261 amortization add-back Investment Loss (223) (45) (39) (23) 17 (207) (50) (50) (Increase)/decrease in 76 48 (301) (195) (221) (339) (1,317) (910) working capital : Other operating cash flow 101 63 (55) 23 187 187 187 187 items Cash flow from 663 958 539 796 1,974 1,928 1,984 3,215 operations
Capital expenditure (189) (263) (315) (709) (989) (900) (900) (400) (Acquisitions)/divestitures 254 2 1 1 6 - - - Investments (27) 53 (38) (358) (16) (100) (100) (100) Other investment cash 13 (136) 174 (260) 40 - - - flow items Cash flow from investing 50 (344) (178) (1,326) (960) (1,000) (1,000) (500)
Dividends paid (301) (287) (263) (271) (292) (292) (416) (537) Share repurchase/issue 42 34 43 60 5 - - - Increase/(decrease) in (140) (123) (498) 906 896 2,300 200 200 debt Other financing cash flow 8 (119) 149 (214) (146) (150) (150) (150) items Cash flow from financing (391) (494) (570) 481 464 1,858 (366) (487) Effect of foreign (7) (14) 13 12 (33) - - - exchange rate changes Total cash flow 316 107 (197) (36) 1,444 2,786 619 2,229 Free cash flow 473 695 223 88 984 1,028 1,084 2,815 Source: Company data, HSBC Qianhai Securities estimates
Valuation We apply a 12m forward PE to value Han’s Laser. We project a net profit CAGR of 29% over 2017-20e, in line with the 32% CAGR during 2008-17. We think it is reasonable to apply a mid- cycle valuation of 22x for the stock, which translates into our target price of RMB50.59, implying 18% upside. With the growing diversification of the customer base and a solid earnings growth outlook, we believe our target multiple valuation and Buy rating are justified.
Downside risks Apple’s innovation progress is slower than expected. In general, smartphone innovation in new design and new processing technology will generate demand for laser equipment. If Apple’s innovation progress is slower than expected, it may cut its laser equipment orders from Han’s Laser.
Laser source import substitution progress is slower than expected. Han’s Laser aims to start high-power laser source in-house supply from 2018. If there is any delay, margin improvement may be hard to achieve.
Regulatory changes in component sourcing policy. Han’s Laser focuses on late-stage assembly and relies on external sourcing of various components such as fiber laser source. Failure to secure those key component presents a downside risk to Han’s Laser’s sales.
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Exhibit 129. Historical 12m forward PE Exhibit 130. Historical 12m forward PB 60.0 9.0
8.0 50.0 7.0
40.0 6.0 +1 STD 5.0 30.0 +1 STD Mean 4.0 Mean 20.0 3.0 -1 STD -1 STD 2.0 10.0 1.0
0.0 0.0
2015/1 2018/7 2010/1 2010/7 2011/1 2011/7 2012/1 2012/7 2013/1 2013/7 2014/1 2014/7 2015/7 2016/1 2016/7 2017/1 2017/7 2018/1
2011/7 2015/7 2018/1 2010/7 2011/1 2012/1 2012/7 2013/1 2013/7 2014/1 2014/7 2015/1 2016/1 2016/7 2017/1 2017/7 2018/7 2010/1 Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
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Financials & valuation: Hans Laser Technology Ind Buy
Financial statements Valuation data Year to 12/2017a 12/2018e 12/2019e 12/2020e Year to 12/2017a 12/2018e 12/2019e 12/2020e Profit & loss summary (CNYm) EV/sales 3.8 3.3 2.3 1.8 Revenue 11,560 13,214 19,005 22,935 EV/EBITDA 21.4 20.1 12.7 9.5 EBITDA 2,045 2,160 3,368 4,313 EV/IC 8.0 6.5 4.9 4.1 Depreciation & amortisation -169 -190 -244 -261 PE* 27.4 23.4 16.5 12.8 Operating profit/EBIT 1,876 1,969 3,124 4,052 PB 6.5 5.2 4.1 3.2 Net interest -222 -131 -152 -153 FCF yield (%) 1.2 1.1 1.3 5.2 PBT 1,786 2,295 3,242 4,169 Dividend yield (%) 0.5 0.6 0.9 1.2 HSBC Qianhai PBT 1,786 2,295 3,242 4,169 * Based on HSBC Qianhai EPS (diluted) Taxation -76 -298 -421 -542 Net profit 1,665 1,947 2,770 3,577 HSBC Qianhai net profit 1,665 1,947 2,770 3,577 Issuer information Cash flow summary (CNYm) Share price (CNY) 42.77 Free float 93% Cash flow from operations 1,974 1,928 1,984 3,215 Target price (CNY) 50.59 Sector Electronic Equipment Capex -989 -900 -900 -400 Reuters (Equity) 002008.SZ Country China Cash flow from investment -960 -1,000 -1,000 -500 Bloomberg (Equity) 002008 CH Analyst Frank He Dividends -213 -292 -416 -537 Change in net debt -780 -486 -419 -2,029 Market cap (USDm) 6,690 Contact +86 755 8898 3136
FCF equity 538 491 577 2,308 Balance sheet summary (CNYm) ESG metrics Intangible fixed assets 752 810 874 944 Tangible fixed assets 2,786 3,617 4,274 4,402 Environmental Indicators Governance Indicators Current assets 8,894 12,697 16,518 20,905 GHG Intensity (kg/USD) na No. of board members 10 Cash & others 2,325 5,111 5,730 7,959 Energy Intensity (kWh/USD) na Average board experience (years) 9.7 Total assets 14,103 18,795 23,337 27,923 CO2 reduction policy Yes Female board members (%) 30 Operating liabilities 4,645 5,304 7,168 8,392 Social Indicators Board members Independence (%) 40 Gross debt 2,174 4,474 4,674 4,874 Net debt -151 -637 -1,056 -3,085 Employee costs as % of sales na Shareholders' funds 6,981 8,715 11,193 14,354 Employee turnover (%) na Invested capital 5,461 6,708 8,767 9,900 Diversity policy Yes Source: Company data, HSBC Qianhai Securities
Ratio, growth and per share analysis Year to 12/2017a 12/2018e 12/2019e 12/2020e Price relative Y-o-y % change Revenue 66.1 14.3 43.8 20.7 62.00 62.00 EBITDA 152.1 5.6 56.0 28.1 Operating profit 183.4 5.0 58.6 29.7 52.00 52.00 PBT 106.0 28.5 41.3 28.6 42.00 42.00 HSBC Qianhai EPS 119.7 16.9 42.3 29.1 Ratios (%) 32.00 32.00 Revenue/IC (x) 2.3 2.2 2.5 2.5 22.00 22.00 ROIC 35.9 28.7 35.6 38.2 ROE 27.1 24.8 27.8 28.0 12.00 12.00 ROA 15.7 12.8 14.0 14.7 2016 2017 2018 EBITDA margin 17.7 16.3 17.7 18.8 Hans Laser Technology Ind Rel to CSI 300 Index Operating profit margin 16.2 14.9 16.4 17.7 Source: HSBC Qianhai Securities EBITDA/net interest (x) 9.2 16.4 22.2 28.2 Net debt/equity -2.1 -7.1 -9.2 -21.0 Note: Priced at close of 03 Sep 2018 Net debt/EBITDA (x) -0.1 -0.3 -0.3 -0.7 CF from operations/net debt Per share data (CNY) EPS Rep (diluted) 1.56 1.82 2.60 3.35 HSBC Qianhai EPS (diluted) 1.56 1.82 2.60 3.35 DPS 0.20 0.27 0.39 0.50 Book value 6.54 8.17 10.49 13.45
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Tongfu Microelectronics (002156 CH)
A top 3 OSAT supplier with a high-quality customer base Benefiting from the robust growth of AMD, MediaTek and Bitmain Initiate with Buy rating and 12m target price of RMB12.05
The pioneer of China’s semiconductor industry Tongfu Microelectronics was founded in 1997 and listed in 2007. The company, headquartered in Jiangsu, Nantong, engages in the IC packaging and testing business. By revenue, the company is ranked seventh among global OSATs and third in China. Tongfu has advanced packaging platforms, including Bumping, WLCSP, FC, BGA and SiP; traditional packaging platforms include QFN, QFP, and DIP, as well as automotive electronics, and MEMS packaging solutions. It also provides wafer testing and system final testing services.
The company is the first domestic packaging and testing company to achieve back-end processes for the mass production of 12-inch 28nm mobile phone processors, including Bumping, Circuit Probing, Flip Chip, and Final Test. Its products are widely used in high-end processors (CPU, GPU), memory, mobile terminals, the Internet of Things, power modules, and automotive electronics.
Exhibit 131. Tongfu’s corporate development Year Events 1997 Nantong Fujitsu was founded. Huada and Fujitsu take 60% and 40% respectively. 2007 Nantong Fujitsu was listed on A-share market. 2009 Became the first domestic company providing BGA packaging; obtained LQFP and Bumping technology from Fujitsu; became the supplier of Toshiba. 2010 Set up the first wafer-level bumping production line. Completed additional A-share public offering. Became the supplier of Texas Instruments. 2011 Developed high-density bumping technology and applied it to high-end chips such as CPU and GPU. Established cooperation with Teramikros (formerly Casio Micro) on WLP advanced packaging technology. 2012 Obtained Cu Pillar bumping technology from Fujitsu, which is critical for advanced tech node IC packaging 2014 Achieved strategic cooperation with a well-known domestic design company; became the supplier of MediaTek. 2015 Completed private placement and acquired 85% stake of two AMD packaging fabs in Suzhou and Penang 2016 Sutong and Hefei fabs were put into operation; renamed as “Tongfu Micro”; became the supplier of Huawei, Spreadtrum, ZTE, Samsung, Broadcom, Socionext. 2017 Invested in Xiamen fab; signed a strategic cooperation agreement with Infineon 2018 Fujitsu sold its stake to Huada, National Big Fund, and local industry fund. Signed a strategic cooperation agreement with Loongon; Became the supplier of domestic DRAM manufacturer Hefei Ruili Source: Company data, HSBC Qianhai Securities
Tongfu began life as a joint venture between Nantong Huada and Fujitsu (China). Through acquisitions and co-development with Japanese companies, Tongfu gradually mastered industry- leading packaging technologies. The company has become the qualified packaging and testing supplier for domestic and foreign semiconductor companies such as Broadcom, MediaTek,
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STMicroelectronics, Texas Instruments, Toshiba, Fuji Electric, Huawei, HiSilicon, and Spreadtrum. Five of the world’s top 10 fabless IC design houses are clients of the company.
Exhibit 132. Tongfu’s client portfolio Exhibit 133. Revenue breakdown by client
Europe, US Japan, Korea, Mainland China Taiwan AMD MediaTek Spreadtrum Texas Instruments Realtek RDA Infineon Fujitsu Leadcore Others STMicro Renesas Silan Micro 31% NXP Ricoh Hisilicon AMD freescale Toshiba Goodix 45% On Semi Rohm Semi Nationz Tech Micronas Niko-sem BCD Semi Fairchild Semi Infineon Spansion 4%
Texas Instruments MediaTek 4% 10% STMicroelectronics 6%
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
As a part of the global semiconductor supply chain, the growth profile of Tongfu is highly correlated with the global semiconductor market. After suffering due to the global financial crisis in 2008 and 2009, the global semiconductor market recorded a strong recovery in 2010. Between 2012 and 2015, Tongfu’s growth was driven by product mix enhancement and improving the client base. The revenue contribution from high-margin advanced packaging platforms has now reached 60-70%. In 2016 and 2017, in order to cope with the rapid development of the domestic semiconductor industry, the company expanded the scale of its business through acquisitions and capex.
Exhibit 134. Tongfu historical revenue Exhibit 135. Tongfu historical net profit trend trend
7,000 120% 200 150% (RMBm) (RMBm) 180 6,000 100% 160 100% 5,000 80% 140 120 50% 4,000 60% 100 3,000 40% 80 0%
2,000 20% 60 40 -50% 1,000 0% 20 - -20% - -100% 20072008200920102011201220132014201520162017 20072008200920102011201220132014201520162017
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
The company has facilities in Nantong Sutong Technology Industrial Park, Anhui Hefei and Xiamen Haicang district, and has built new fabs at Sutong, Hefei and Xiamen. In April 2016, with the support of the national “Big Fund”, Tongfu acquired an 85% stake in AMD’s Suzhou and Penang fabs (AMD still holds 15%) for USD370.6m. The deal was completed in two stages. First, Tongfu and the Big Fund provided 22.5% and 62.5% of the amount in cash, respectively. In the second stage, completed in December 2017, Tongfu acquired the Big Fund’s 62.5% stake through a private placement. As a result, 85% of profits from Suzhou and Penang fabs will absorbed by Tongfu from January 2018.
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AMD’s Suzhou and Penang fabs have leading-edge advanced flip-chip packaging and testing technology. The main products are used in high-end applications such as computers, servers, high-end game consoles, and cloud computing centres. The transaction means that Tongfu has obtained mass production technology and know-how about advanced packaging. Meanwhile, the two fabs will continue to serve as the primary packaging and testing supplier for AMD and transition to the OSAT business model.
According to company guidance, AMD allocates over 80% of its IC packaging and testing orders to the Suzhou and Penang fabs. The two fabs now actively respond to AMD orders and have developed 7nm wafer node technology, launched a number of new products, and acquired many high-profile new customers. In 2017, the two fabs’ revenue grew by 24% y-o-y.
The two new fabs at Sutong and Hefei went into operation in September 2016 and utilization rates are ramping up. At the Sutong fab, which is an additional production base for high-end products, the number of clients has increased from 13 in early 2017 to 29, and the production output has increase from a daily average of 200,000 units in early 2017 to 1.2m units.
The Hefei fab is focused on supporting the local IC industry. The number of clients has increased from 11 in early 2017 to 33 and output has increased from a daily average of 3m units in early 2017 to 11m units. Over 2017-19 the Heifei fab will build a world leading LCD driver packaging and testing production line to support local panel makers, such as BOE. The fab has also been selected as a supplier of Heifei Ruili, the strategic partner of GigaDevice, to co-develop packaging and testing technology for high-end DRAM products.
In June 2017, Tongfu signed a strategic cooperation agreement with the Xiamen Haicang government to build an advanced packaging and testing fab in Xiamen. Tongfu invested RMB30m, giving it a 10% stake. At the time of break-even, Tongfu will acquire the remaining stake from the government at the original invested price.
Exhibit 136. Six fabs and packaging platforms Chongchuan Suzhou Penang Sutong Hefei Xiamen (10% ownership) Bumping 8/12'' solder/copper FCBGAs FCBGAs BGAs, LGAs, FCCSP ICs (High Density) WLCSP WLCSP FCLGAs FCLGAs FCBGA, FCCSOP Memory Copper Pillar BGAs, LGAs, FCCSP FCPGAs FCPGAs QFN Test services Gold bumping QFNs, QFPs, ICs Coreless BGAs Coreless BGAs Test services Power Packaging Test services Bumping Test services Test services Source: Company data, HSBC Qianhai Securities
Top client AMD has positive momentum AMD, the US multinational, is Tongfu’s largest client and accounted for 45% of the company’s revenue in 2017. AMD wasn’t very competitive for several years but is regaining ground on its two much larger competitors, Intel and Nvidia. Based on newly-developed Zen and Vega micro- architecture, the company had great success in launching the Ryzen family of CPUs and Radeon GPUs. The revenue of its computing and graphics segment surged 54% in 2017. Enterprise, embedded, and semi-custom segment revenue grew 3%, driven by the new family of high-performance EPYC processor platforms for the datacentre.
Looking ahead, AMD hopes to build on this momentum with the next wave of premium products. In the PC market, the company expects more than 60 new Ryzen processor-based OEM commercial and consumer systems to launch throughout 2018. In the graphics market, the company aims to expand the Radeon “Vega”-architecture based line-up into high-end notebooks, and start sampling the first 7nm node GPU for machine learning later in 2018.
In the datacentre segment, the company will continue to work closely with major cloud vendors and OEMs to ramp their first-generation EPYC processor-based systems, while also completing
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development milestones on the next-generation “Zen 2” architecture-based server platforms. AMD aims to achieve double-digit market share in the USD16bn datacentre market in the coming years, up from 1% in 2017.
Exhibit 137. AMD is gaining market share Exhibit 138. AMD revenue trend
3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 9,000 40.0% AMD PC CPU 9.1% 9.9% 11.4% 11.1% 10.9% 12.0% (USDm) 8,000 30.0%
7,000 GPU supplier 4Q17 2017 1Q18 20.0% 6,000 AMD 27.2% 29.5% 33.7% 10.0% Nvidia 72.8% 70.5% 66.3% 5,000 0.0% 4,000 -10.0% 3,000 -20.0% 2,000
1,000 -30.0%
- -40.0% 2012 2013 2014 2015 2016 2017 2018e2019e2020e Revenue Yoy Source: Mercury Research, Jon Peddie Research Source: Company data, Bloomberg consensus estimates
MediaTek, Tongfu’s second largest client, accounted for about 10% of revenue in 2017. The Taiwanese company has been losing market share to Qualcomm and Spreadtrum in the past year due to a slowdown in product upgrades. The company is now back on a growth track and revenue grew 21.8% y-o-y to USD2bn in 2Q18. This was driven by the adoption of its AI capable mobile SoCs, such as Helio P60 chip, by a number of China-based smartphone vendors, including Xiaomi, Oppo and Vivo.
MediaTek announced that it has joined China Mobile’s ‘5G Device Forerunner Initiative’ program to jointly develop 5G terminal devices and 5G chipsets. As one of the first chip makers participating in the program, MediaTek announced its first 5G baseband chipset, Helio M70, will be ready in 2019. In addition to its core smartphone business, MediaTek has been shifting more of its business to chips for IoT, game consoles and ASICs, which account for about one third of the company’s total revenue. The company has sold IoT chips to new customers such as Amazon, Google and Chinese internet companies. Automotive electronics will be the next target in terms of MediaTek’s long-term business growth.
Exhibit 139. MediaTek shipment trend Exhibit 140. MediaTek revenue trend 140 60% 350,000 70.0% (m units) 50% (TWDm) 60.0% 120 300,000 40% 50.0% 100 30% 250,000 40.0% 20% 80 200,000 30.0% 10% 60 150,000 20.0% 0% 10.0% 40 -10% 100,000 0.0% -20% 50,000 20 -10.0% -30% - -20.0% - -40% 2012 2013 2014 2015 2016 2017 2018e2019e2020e Revenue Yoy Smartphone chip shipment Yoy
Source: Company data, HSBC estimates Source: Company data, Bloomberg consensus estimates
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Well positioned in the automotive IC market According to IC Insights, the global automotive IC market in 2017 totalled USD27.2bn, accounting for 7.5% of the total IC market. IC Insights forecasts the automotive IC market to grow to USD43.6bn in 2021, which a 12.5% CAGR for 2017-21, the highest among the six major end-use applications.
Automotive IC’s are traditionally wire-bond packages. Due to the increasing complexity and higher performance requirements of automotive applications, the packaging industry is moving towards high performance advanced flip chip, fan-out and SiP packages for automotive infotainment, GPS, and radar applications.
Tongfu is well positioned in the fastest growing automotive IC market. Among the top 10 automotive IC vendors worldwide, seven of them are Tongfu’s existing clients. Moreover, the company has a strategic cooperation agreement with Infineon to help enhance Tongfu’s manufacturing capabilities and productivity by sharing Germen industry 4.0 experience and acknowledge.
According to the agreement, the cooperation between two parties will be carried out in stage. Infineon will evaluate the current manufacturing capability of Tongfu in terms of equipment productivity, production cycle, on-time delivery and quality, and propose a manufacturing improvement plan. As part of the cooperation, Infineon also assisted Tongfu in setting up a 4.0 intelligent manufacturing demonstration production line at the Hefei fab in 2017.
Exhibit 141. 2017 Automotive IC vendor Exhibit 142. IC market growth by end-use market share application (2017-2021e CAGR)
Ranking Company Market share 1 NXP 12.5% Automotive 12.5% 2 Infineon 10.8% 3 Renesas 10.0% Industial 8.1% 4 Texas Instruments 8.0% 5 STMicro 7.1% Consumer 6.8% 6 Bosch 5.5% 7 ON Semi 4.8% Total Ics 6.1% 8 Rohm Semi 2.7% 9 Toshiba 2.7% Computer 5.4% 10 ADI 2.6%
Gov/Mil 5.2%
Comm 4.6%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%
Source: Strategy Analytics Source: IC Insights
New revenue stream from cryptocurrency mining Cryptocurrency mining, or cryptomining, is a process in which transactions for various forms of cryptocurrency are verified and added to the blockchain digital ledger. Also known as cryptocoin mining, altcoin mining, or Bitcoin mining (for the most popular form of cryptocurrency, Bitcoin), cryptocurrency mining activity has increased rapidly in the last few years.
Cryptocurrency mining was originally designed to be something everyone could do with their home computer. Those days are long gone. Today, whether you’re mining Bitcoin, Litecoin, DASH, or a host of other cryptocurrencies, the most effective way to do so is with a piece of hardware known as an ASIC miner. Application specific integrated circuits, or ASICs, are chips that are designed with a singular purpose, ranging from audio processing to managing a cellphone call. In the case of cryptocurrency mining, these chips are built into specifically- designed motherboards and power supplies, constructed into a single unit.
Frost and Sullivan forecasts the ASIC-based hardware market will reach RMB28.6bn in 2020 from RMB2.6bn in 2016, implying an 82% CAGR. According to the prospectus of Canaan
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Creative, which produces blockchain servers and designs ASIC microprocessor solutions, Chinese producers dominate the ASIC miner market. Bitmain takes nearly 70% market share, followed by Canaan Creative 20%, Ebang 4%, and Pangolin 2%. About 1.5m mining units were shipped in 2017, so we estimate that over 200m ASIC chips were shipped (assuming each miner carries 150 ASIC chips on average). We expect Tongfu, as the main packaging and testing supplier of Bitmain ASIC processor, to benefit from this new market.
Exhibit 143. Mainstream Bitcoin miners Exhibit 144. Blockchain hardware market size 40.0 Ant miner S9i Avalon miner A841 (RMBbn) Producer Bitmain Canaan Creative 35.0 Processor 189 units of BM1387 104 units of A3210 6.9 16nm ASIC chips 16nm ASIC chips 30.0 5.6 Rated calculation 13.5Hash/s 13Hash/s 25.0 power Rated power 1320W/h 1290W/h 20.0 Price RMB4500 RMB7600 2.9 15.0 28.6 24.0 10.0 1.4 14.6 5.0 0.8 7.3 2.6 0.0 2016 2017 2018e 2019e 2020e Non-ASIC based blockchain hareware ASIC-based blockchain hareware
Source: Company data, HSBC Qianhai Securities Source: Frost & Sullivan
Introducing new clients to improve utilization Tongfu’s margin has been dragged down by the low utilization rate of the two new fabs at Sutong and Hefei. Introducing clients to a new fab usually takes 1.5-2 years as it takes time to complete IC packaging platform verification. The fabs started operating in September 2016. According to the company guidance, the two fabs lost nearly RMB100m on a net basis in 2017 but gross profit turned positive (RMB2-3m) in 1Q18. The company expects the two fabs to break even by the end of 2018, which should drive margin improvement.
Another positive is that AMD orders now account for about 80% of the capacity of the Suzhou and Penang fabs. Given the strong demand from AMD and the introduction of new clients in the coming quarters, the company guided an RMB2.4bn capex in 2018 to increase capacity. Broadcom and IDT’s products are mass produced at the Penang fab, and ZTE’s new product has started mass production at Suzhou. Samsung has completed the verification process, while Socionext, UMC and Higon have entered the verification stage. Pango ( ), Loongson ( ), and Brigates ( ) have entered the sample trial production stage.
Forecasts and valuation
Earnings forecast We forecast a 44% net profit CAGR during 2018-20e, driven by an 18% revenue CAGR, margin expansion through vertical integration, as well as operating leverage.
We expect the Suzhou and Penang fabs to have a 20% revenue CAGR during 2018-20e thanks to strong demand from AMD and the introduction of new clients. We also expect the other three fabs – Chongchuan, Sutong and Hefei – to have revenue CAGRs of 15%, 27% and 27% in this period, driven by rising demand from automotive electronics and cryptocurrency mining, as well as new clients.
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We expect the gross margin to improve from 14.5% in 2017 to 19.0% in 2020e, driven by capacity utilization improvement in the new fabs. We expect the SG&A to revenue ratio to decline over time thanks to efficiency enhancements.
Exhibit 145. Revenue and gross profit forecast RMBm 2016 2017 2018e 2019e 2020e CAGR 18-20e Chongchuan 2,825 3,265 3,852 4,430 5,095 15% Suzhou and Penang 1,740 2,955 3,546 4,256 5,107 20% Sutong 2 147 400 520 650 27% Hefei 25 153 400 520 650 27% Total 4,592 6,519 8,199 9,726 11,501 18% Gross profit 826 943 1,394 1,751 2,185 Gross profit margin 18.0% 14.5% 17.0% 18.0% 19.0% Source: Company data, HSBC Qianhai Securities estimates
Sensitivity analysis We think the two AMD fabs’ revenue growth and Chongchuan fab revenue growth are the two critical swing factors for earnings. Our earnings sensitivity analysis for 2018e suggests that for every 5% difference in the AMD fabs’ revenue growth, earnings would change by 1.0%; for every 5% difference in Chongchuan fab revenue growth, earnings would change by 2.3%.
Exhibit 146. Sensitivity analysis for 2018e earnings (RMBm) ______AMD fabs’ revenue growth ______10% 15% 20% 25% 30% 8% 285 288 291 294 297 Chongchuan fab revenue 13% 293 296 299 302 305 growth 18% 300 303 306 309 312 23% 308 311 314 317 320 28% 315 318 321 324 327 Source: HSBC Qianhai Securities estimates
Balance sheet and cash flow Tongfu had net debt of RMB997m as at 2017, with a healthy net gearing level of 16.8%. It has consistently generated positive operating cash flow, but free cash flow has been negative since 2014 due to the capex on new fabs.
The company guided for RMB2.4bn capex in 2018 for capacity expansion. Hence, we expect the company’s free cash flow to stay negative and the net gearing ratio to increase in 2018. Beyond that, with an improving margin and ROE, we expect the company’s free cash flow to turn positive and net gearing ratio to decrease gradually. As the company is still in an expansion cycle with more capital committed to new fabs, we expect the company to pay a dividend after 2019.
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Exhibit 147. Balance sheet statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Cash and equivalents 765 561 1,438 1,603 1,704 1,692 2,335 3,516 Net receivables 356 422 522 1,291 1,626 2,045 2,426 2,868 Inventory/stocks 250 274 318 782 975 1,190 1,395 1,629 Other current assets 29 72 661 266 132 132 132 132 Total Current assets 1,400 1,329 2,939 3,942 4,437 5,059 6,288 8,146
Net PP&E/Fixed assets 1,874 2,318 2,715 5,027 5,665 6,913 7,211 7,038 Net intangibles 72 95 125 285 267 307 314 322 Total investments 32 28 39 38 69 69 69 69 Other long-term assets 309 185 695 1,911 1,708 1,488 1,282 1,056 Total non-current asset 2,287 2,626 3,573 7,262 7,709 8,778 8,877 8,485 Total assets 3,686 3,955 6,512 11,203 12,146 13,838 15,165 16,632
Accounts payable 527 568 562 1,788 1,748 2,133 2,500 2,920 Short-term debt and 513 591 983 1,468 1,928 1,928 1,928 1,928 current portion of long- term debt Other current liabilities 16 17 15 59 53 53 53 53 Current liabilities 1,057 1,175 1,560 3,316 3,730 4,115 4,482 4,902
Long-term debt 120 152 476 301 772 1,772 2,272 2,772 Other long-term 253 263 736 1,445 1,387 1,387 1,387 1,387 liabilities/creditors Total long-term liabilities 373 416 1,212 1,746 2,158 3,158 3,658 4,158 Total liabilities 1,430 1,591 2,772 5,061 5,888 7,273 8,140 9,060
Common stock 650 650 748 973 1,154 1,154 1,154 1,154 Treasury stock Reserve 1,606 1,714 2,992 2,925 4,765 5,072 5,533 6,079 Other common equity 0 0 1 20 0 - - - Total common equity 2,256 2,364 3,740 3,918 5,919 6,225 6,686 7,232 Minority interest - - - 2,223 339 339 339 339 Total equity 2,256 2,364 3,740 6,142 6,258 6,564 7,025 7,571 Total liabilities and equity 3,686 3,955 6,512 11,203 12,146 13,838 15,165 16,632 Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 148. Cash flow statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Net income 61 121 147 181 122 306 461 638 Minority interest and 11 16 14 100 69 39 54 70 impairment add-back Depreciation and 251 292 355 655 893 1,181 1,237 1,212 amortization add-back Investment Loss 3 3 (14) 1 (2) - - - (Increase)/decrease in (66) (52) (312) (156) (212) (249) (219) (257) working capital : Other operating cash flow 50 36 41 4 140 140 140 140 items Cash flow from 309 415 231 785 1,010 1,418 1,673 1,803 operations
Capital expenditure (119) (664) (1,251) (1,561) (1,657) (2,400) (1,500) (1,000) (Acquisitions)/divestitures 2 0 1 0 33 - - - Investments 15 1 4 6 (30) - - - Other investment cash (37) 5 (679) (1,909) 4 - - - flow items Cash flow from investing (139) (657) (1,925) (3,464) (1,650) (2,400) (1,500) (1,000)
Dividends paid (52) (47) (68) (89) (92) - - (92) Share repurchase/issue - - 1,253 1,809 - - - - Increase/(decrease) in (62) 110 968 147 912 1,000 500 500 debt Other financing cash flow (6) (10) 312 1,011 (30) (30) (30) (30) items Cash flow from financing (120) 53 2,464 2,878 790 970 470 378 Effect of foreign (13) 1 15 (4) (37) - - - exchange rate changes Total cash flow 38 (189) 786 194 113 (11) 643 1,181 Free cash flow 190 (249) (1,020) (777) (647) (982) 173 803 Source: Company data, HSBC Qianhai Securities estimates
Valuation We apply a 12m forward PE to value Tongfu. As earnings were cyclical up to 2015 the company’s shares have historically traded in a quite wide multiple range, with a mid-cycle forward PE of 60x and one-standard deviation of 33x. But since the acquisition of AMD’s packaging and testing fabs in 2016, we believe Tongfu’s revenue and earnings growth profile and has structurally changed and become less volatile and more predictable.
We forecast a 44% net profit CAGR over 2018-20e, which is slightly higher than the A-share semiconductor sector average earnings CAGR of 37%. Therefore, we apply the A-share semiconductor peer group’s valuation matrix to value the stock. We apply 35x forward PE to Tongfu, in line with A-share sector average multiple. Accordingly, we derive a target price of RMB12.05, implying 20% upside.
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Exhibit 149. Comparable A-share semiconductor value chain Ticker Company Currency Price Market cap DAV _ PE (x) __ PS (x) PB (x) EPS CAGR EV/EBITDA ROE (%) Div yield (%) USDm USDm 18e 19e 18e 18e 18-20e 18e 18e 18e A-share 002371 CH NAURA TECH CNY 53.26 3,576 99 101.9 64.3 7.2 6.8 53% 51.4 7.1 0.2 002008 CH HAN'S LASER CNY 42.77 6,677 99 21.4 16.4 3.2 5.2 30% 18.5 25.0 1.0 002156 CH TONGFU MICRO CNY 10.05 1,696 13 30.0 19.9 1.4 1.8 39% 10.6 6.2 0.9 603986 CH GIGADEVICE SEMI CNY 110.00 4,566 86 49.5 34.3 10.2 14.5 45% 46.1 30.9 0.3 600584 CH JCET CNY 15.11 3,539 31 32.9 19.9 0.9 2.3 51% 9.4 7.1 0.3 300316 CH ZHEJIANG JINGSHENG CNY 12.46 2,357 34 23.0 17.9 5.0 3.9 25% 19.6 16.6 1.2 002049 CH UNIGROUP GUOXIN CNY 43.04 3,849 133 66.7 54.4 10.6 6.9 22% 41.8 11.1 0.2 300613 CH SHANGHAI FULLHAN CNY 119.85 801 7 40.4 28.0 8.9 5.0 37% 25.9 12.3 0.2 002185 CH TIANSHUI HUATIAN CNY 5.06 1,584 15 18.0 14.4 1.3 1.8 24% 8.3 10.1 0.9 600703 CH SANAN OPTOELECTRONICS CNY 15.94 9,458 95 16.4 12.8 6.0 2.8 27% 10.4 17.5 2.2 600460 CH HANGZHOU SILAN CNY 11.35 2,179 59 61.8 47.2 4.4 5.0 28% 33.2 8.6 0.8 300672 CH GOKE MICRO CNY 51.04 840 16 76.5 38.8 11.5 0.0 54% - 7.1 0.0 300666 CH KONFOONG MATERIALS CNY 47.00 1,518 36 124.2 85.5 13.6 16.0 38% 80.7 13.0 0.0 300458 CH ALL WINNER TECH CNY 23.67 1,153 21 49.2 35.2 5.1 3.6 38% 32.0 7.1 0.0 603005 CH CHINA WAFER LEVEL CSP CNY 20.23 692 6 37.2 24.7 5.9 2.5 44% 14.7 6.6 0.0 300323 CH HC SEMITEK CNY 11.60 1,872 12 15.9 11.6 3.0 2.4 33% 11.9 16.6 0.5 47.8 32.8 6.1 5.0 37% 27.6 12.7 0.5 Share prices as at 3 Sep 2018 Source: Company data, Wind, Bloomberg
Downside risks Market share loss with key customers: Tongfu has around 80-90% market share in AMD’s packaging and testing business, so we see limited chance of this improving. Also, AMD has divested its majority ownership in the Suzhou and Penang fabs. According to the acquisition agreement, AMD guarantees that the two fabs will generate not less than USD20m profit in the following three years, otherwise AMD will cover any shortfall. This guarantee will expire in 2019. Although AMD still has 15% ownership, it will have more options in terms of packaging and testing suppliers by then, leading to downside risk for sales.
Raw material and key component sourcing: Tongfu relies on external souring of raw materials such as bonding wire, molding material and key components such as lead frame and substrate. Any regulatory changes or natural disaster causing a supply shortage would lead to downside risk to sales and margins. g
Longer-than-expected new customer order wins: The IC packaging and testing business needs a long period of time for product verification. It takes about two years to introduce new clients and even longer for automotive electronics clients due to high requirements for reliability. Slower-than-expected progress in verification would be a downside risk for sales.
Exhibit 150. Historical 12m forward PE Exhibit 151. Historical 12m forward PB 180.0 8.00
160.0 7.00 140.0 6.00 120.0 5.00 100.0 +1 STD 4.00 80.0 +1 STD Mean 3.00 60.0 Mean 2.00 40.0 -1 STD 1.00 20.0 -1 STD
0.0 0.00
2009/8 2011/2 2012/8 2014/2 2017/2 2007/8 2008/2 2008/8 2009/2 2010/2 2010/8 2011/8 2012/2 2013/2 2013/8 2014/8 2015/2 2015/8 2016/2 2016/8 2017/8 2018/2
2016/2 2018/2 2008/2 2008/8 2009/2 2009/8 2010/2 2010/8 2011/2 2011/8 2012/2 2012/8 2013/2 2013/8 2014/2 2014/8 2015/2 2015/8 2016/8 2017/2 2017/8 2007/8 Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
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Financials & valuation: TongFu Microelectronics Buy
Financial statements Valuation data Year to 12/2017a 12/2018e 12/2019e 12/2020e Year to 12/2017a 12/2018e 12/2019e 12/2020e Profit & loss summary (CNYm) EV/sales 1.9 1.7 1.4 1.1 Revenue 6,519 8,199 9,726 11,501 EV/EBITDA 11.2 8.5 7.2 6.1 EBITDA 1,119 1,591 1,870 2,077 EV/IC 1.7 1.6 1.5 1.5 Depreciation & amortisation -893 -1,181 -1,237 -1,212 PE* 77.3 37.8 25.2 18.2 Operating profit/EBIT 226 409 633 866 PB 2.0 1.9 1.7 1.6 Net interest -198 -137 -173 -190 FCF yield (%) -8.1 -10.7 -0.7 4.8 PBT 178 373 561 776 Dividend yield (%) 0.0 0.0 0.0 0.8 HSBC Qianhai PBT 178 373 561 776 * Based on HSBC Qianhai EPS (diluted) Taxation 19 -37 -56 -78 Net profit 122 306 461 638 HSBC Qianhai net profit 122 306 461 638 Issuer information Cash flow summary (CNYm) Share price (CNY) 10.05 Free float 84% Cash flow from operations 1,010 1,418 1,673 1,803 Target price (CNY) 12.05 Sector It Services Capex -1,657 -2,400 -1,500 -1,000 Reuters (Equity) 002156.SZ Country China Cash flow from investment -1,650 -2,400 -1,500 -1,000 Bloomberg (Equity) 002156 CH Analyst Frank He Dividends 0 0 0 -92 Change in net debt 831 1,011 -143 -681 Market cap (USDm) 1,700 Contact +86 755 8898 3136
FCF equity -928 -1,232 -77 553 Balance sheet summary (CNYm) ESG metrics Intangible fixed assets 267 307 314 322 Tangible fixed assets 7,373 8,401 8,493 8,094 Environmental Indicators Governance Indicators Current assets 4,437 5,059 6,288 8,146 GHG Intensity (kg/USD) na No. of board members 9 Cash & others 1,704 1,692 2,335 3,516 Energy Intensity (kWh/USD) na Average board experience (years) 4.4 Total assets 12,146 13,838 15,165 16,632 CO2 reduction policy Yes Female board members (%) 11.1 Operating liabilities 3,188 3,573 3,940 4,360 Social Indicators Board members Independence (%) 33.3 Gross debt 2,700 3,700 4,200 4,700 Net debt 997 2,008 1,865 1,184 Employee costs as % of sales na Shareholders' funds 5,919 6,225 6,686 7,232 Employee turnover (%) na Invested capital 7,186 8,503 8,821 8,686 Diversity policy Yes Source: Company data, HSBC Qianhai Securities
Ratio, growth and per share analysis Year to 12/2017a 12/2018e 12/2019e 12/2020e Price relative Y-o-y % change Revenue 42.0 25.8 18.6 18.3 18.60 18.60 EBITDA 32.2 42.2 17.6 11.1 16.60 16.60 Operating profit 18.2 81.0 54.7 36.7 14.60 14.60 PBT -27.1 109.7 50.4 38.3 HSBC Qianhai EPS -31.6 104.3 50.4 38.5 12.60 12.60 Ratios (%) 10.60 10.60 Revenue/IC (x) 1.0 1.0 1.1 1.3 ROIC 4.1 5.0 6.9 9.3 8.60 8.60 ROE 2.5 5.0 7.1 9.2 6.60 6.60 ROA 3.6 3.5 4.6 5.5 2016 2017 2018 EBITDA margin 17.2 19.4 19.2 18.1 TongFu Microelectronics Rel to CSI 300 Index Operating profit margin 3.5 5.0 6.5 7.5 Source: HSBC Qianhai Securities EBITDA/net interest (x) 5.6 11.6 10.8 10.9 Net debt/equity 15.9 30.6 26.5 15.6 Note: Priced at close of 03 Sep 2018 Net debt/EBITDA (x) 0.9 1.3 1.0 0.6 CF from operations/net debt 101.3 70.6 89.7 152.3 Per share data (CNY) EPS Rep (diluted) 0.13 0.27 0.40 0.55 HSBC Qianhai EPS (diluted) 0.13 0.27 0.40 0.55 DPS 0.00 0.00 0.00 0.08 Book value 5.13 5.40 5.80 6.27
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GigaDevice (603986 CH)
Leading NOR flash and MCU supplier keeps gaining market share NAND flash and DRAM are long-term growth drivers Initiate with a Hold rating and a target price RMB107.19
Broadening product portfolio to drive growth
GigaDevice is a leading memory chip design company with strong exposure to microcontrollers and non-volatile memory devices such as NOR flash and NAND flash. It is a top-five global NOR flash supplier with 13% market share and is China’s largest NOR flash and NAND flash supplier. The company was established in 2005 and has been involved with R&D in NOR flash since 2007.
Over the past decade, GigaDevice’s NOR flash technology has advanced from 130nm to 45nm, covering 1.8V, 2.5V and 3.0V. In addition, GigaDevice started to mass produce microcontroller units (MCU) in 2013 and NAND flash in 2017. The company is also partnering with Hefei Changxin to develop 12-inch 19nm DRAM. Key customers include Spreadtrum, RDA Microelectronics, MediaTek, Samsung, and IC component distributors. In 2017, China’s National IC Fund (the “Big Fund”) took an 11% stake in the company.
Apart from organic growth, GigaDevice is also looking for M&A opportunities. The company is in the process of acquiring a 100% stake in Shanghai Silead, a leading fingerprint chip designer. NOR flash and microcontrollers are the main products, accounting for 84% and 15% of total revenue in 2017.
Thanks to market share gains in NOR flash and product portfolio expansion, GigaDevice achieved a 27% revenue and 56% net profit CAGR during 2013-17. Its gross margin has also been rising in the past few years thanks to higher NOR flash prices and better product mix.
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Exhibit 152. Corporate development history Year Events 2005 Established in Beijing, mainly focused on the R&D of SRAM 2006 Low power SRAM in production 2007 Shifting the R&D focus to NOR flash 2009 The first 130nm 3.0V SPI NOR flash in mass production 2010 512K~32Mb NOR Flash in mass production The first 90nm product 3.0V SPI NOR flash in production 2011 Starts R&D of 32-bit ARM-based MCU 2012 Starts R&D in 65nm, with annual chip sales to 590m units Mass production of 65nm NOR flash; 810m units sales 2013 ARM Cortex 32 bit MCU is released 2014 NOR flash products enters wearable and smart home industry 2016 Listed in Shanghai Stock Exchange Proposes acquiring ISSI, a leading SRAM and DRAM supplier, but fails China National IC Fund purchases 11% share of GigaDevice 2017 Starts mass production of 38nm NAND Flash Partnership with Hebei municipal government to develop 19nm DRAM Invests 1% stake in SMIC for HKD533m Proposes acquiring 100% stake in Shanghai Silead and intends to invest in 14nm 2018 Inferencing AI chip and 30MHz ultrasound sensor To form JV with Rambus and THG Ventures to develop RRAM
Source: Company data, HSBC Qianhai Securities
Exhibit 153. Revenue growth trend Exhibit 154. Gross margin trend 2,100 (RMBm) 47.9% 311 50.0% 1,800 43.1% 40.0% 39.4% 39.2% 1,500 27% CAGR 40.0% 37.6% 197
1,200 28.7% 127 30.0% 27.3% 26.7% 24.9%25.2% 24.2% 15 900 1,716 21.9%21.9% 1 20.0% 600 1,292 1,062 931 787 300 10.0%
- 0.0% 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Memory Microcontroller Others
Memory Microcontroller Overall Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Gaining market share We think GigaDevice is becoming more competitive and has the potential to become a tier-one player in NOR flash in the coming five years.
GigaDevice’s NOR flash product covers 512Kb to 1Gb density and 130nm-45nm by geometry, which is comparable to Macronix and Winbond. Its products are widely used in consumer electronics, mobile phones, computing, IoT auto and industrial sectors. It has a large market share in feature phones, WiFi routers, PC mainboards, notebooks, set-top boxes, USB keys, smart TVs, surveillance cameras, graphic cards, and GPS navigation.
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The company also recently became a supplier of 32MB NOR flash for Samsung’s Galaxy S9 camera modules, together with Winbond. The memory is used for image processing purposes. That said, GigaDevice already a leading player in the low-density product category.
Its growth strategy is to continue to gain market share in the low-density segment (<128Mb) while enhancing its know-how in high-density products. As Macronix and Winbond have both expressed their intention to focus on high-density products, we expect GigaDevice will continue to gain traction in the low-density category. In the high-density category, GigaDevice indicates that 128MB and 256MB above products accounted for around 20% of sales in 2017.
In terms of node technology, two-thirds of its revenue was generated from 65nm in 2015, with most of the balance coming from 90mn. In 2018, the company has assigned SMIC to produce 45nm products on a small scale and we expect sales to make a revenue contribution in 2019.
Although GigaDevice only accounted for low teens’ market share of the NOR flash market in terms of revenue in 2017, its market share in total volume shipments is about 30%, down from 43% in 2015. This suggests its average selling price is lower than the industry average. But this pricing discount has narrowed from 74% in 2015 to 57% in 2017, implying that GigaDevice is moving up the value chain and gaining traction in high-density, high-quality product categories.
Exhibit 155. NOR flash volume shipment Exhibit 156. NOR flash ASP comparison share
6,000 5,710 45% 4.00 0% 3.62 (m) 43% (RMB) 4,923 40% 3.50 -10% 5,000 2.90 4,253 34% 35% 3.00 2.80 -20% 3,959 4,000 30% 30% 3,461 2.50 2.31 2.30 -30% 26% 25% 3,000 2.00 -40% 20% 20% 1.50 -50% 2,000 1,686 1,736 15% 1,478 0.97 0.99 0.84 -57% 1,108 10% 1.00 0.72 0.77 -60% 1,000 810 5% 0.50 -71% -67% -70% -73% -74% - 0% - -80% 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017 Global NOR Flash volume GigaDevice volume GigaDevice Global average Discount GigaDevice market share Source: WSTS, Company data, HSBC Qianhai Securities Source: WSTS, Company data, HSBC Qianhai Securities
We believe the fabless model provides flexibility in terms of production capacity and technology advantages, and also enables the company to focus on IC design. As a shareholder of SMIC, we believe GigaDevice receives strong support from SMIC in terms of capacity allocation and technical know-how. Also, GigaDevice is able to leverage SMIC’s expertise and R&D in advanced wafer fabrication to compete with global peers. SMIC produces 28nm IC and is in the process of migrating to14nm. As at the end of 2017, 61% of its employees worked in the R&D department; the company has filed 781 patents and been granted 261.
The company also has access to a low cost of equity financing to support new product R&D and M&A. GigaDevice is trading at premium valuation to overseas peers, which means it is able to raise capital at lower cost, which we think helps explain its proposal to acquire Shanghai Silead and its previous unsuccessful effort to acquire ISSI in 2017.
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Exhibit 157. Gross margin comparison Exhibit 158. R&D as % of total revenue comparison 60.0% 35.0%
50.0% 30.0%
25.0% 40.0% 20.0% 30.0% 15.0% 20.0% 10.0% 10.0% 5.0%
0.0% 0.0% 2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016 2017 Cypress Micrcon Macronix Winbond GigaDevice
Cypress Micrcon Macronix Winbond GigaDevice Source: Company data Source: Company data
MCU Microcontroller (MCU) is a small computer on a single IC. It consists of processors (CPU), memory and input/output peripherals (display, RF, switches, sensors) that can be used as an embedded system. Most MCU in use today are embedded in equipment, and widely used in automobiles, industrials, consumer electronics, and IoT. This is in contrast to microprocessors (MPU) that are used in PCs or other applications that consist of various discrete chips.
GigaDevice started its R&D of MCU in 2011 and in 2013 launched the first 32-bit general- purpose ARM Cortex M3 MCU, which was mainly applied in entry-level industrial and consumer IoT markets. Industrial applications include long-range data collection, safety controls, and environmental monitoring, while consumer applications cover smart appliances, smart meters, and home gateways. It then launched the 32-bit ARM Cortex-M4 series MCU in 2016, targeting fingerprint technology, wireless charging, high-performance computing, and graphic design. 32- bit is now the prevailing standard for high-performance MCUs, accounting for roughly 40% of the total MCU market, with the balance from 8- and 16-bit. In terms of technology node, it is in the process of reviewing a possible migration from 55nm to 40nm.
Leveraging on its expertise in memory, a critical part of MCU, we think GigaDevice can extend its product portfolio by entering the MCU market. MCU is a much larger market than NOR flash. According to IC Insights, the global MCU market’s revenue was USD17.9bn in 2017, which is almost 9x higher than that for NOR flash.
IC Insights forecasts that the MCU market, fuelled by applications in autos, IoT and industrial controls, will reach USD20.9bn in 2020, implying a CAGR of 6.3%. The MCU market is dominated by overseas suppliers such as NXP, Renesas and Microchip. GigaDevice’s market share in MCU is below 3%, so we see ample room for growth.
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Exhibit 159. MCU market share breakdown Exhibit 160. Global MCU market size in 2016 forecast 30 1.0 (bn) (USD) Others 0.9 14% NXP 25 0.8 Cypress 19% 0.7 4% 20 Texas 0.6 Instrument 15 0.5 5% Renesas 16% 0.4 Infineon 10 7% 0.3 0.2 5 STMicroelect 0.1 ronics 10% Microchip 0 - 2013 2014 2015 2016 2017 2018e 2019e 2020e 13% Samsung Market size (USD) (LHS) Units (LHS) ASP (RHS) 12% Source: IC Insights, HSBC Qianhai Securities Source: IC Insights, HSBC Qianhai Securities
Revenue from the MCU business has increased from RMB15m in 2014 to RMB311m in 2017, a CAGR of 175%. In addition, due to more customization and less direct competition, the MCU margin is higher than in its flash memory unit. GigaDevice currently has over 300 MCU products with cumulative unit sales exceeding 200m as at May 2018, serving over 10,000 customers.
Exhibit 161. A typical wearable MCU Exhibit 162. GigaDevice MCU margin and architecture ASP 5.00 60.0% Apps. Always ON Display Video GPU (RMB) CPU CPU Processor Processor 4.50 4.40 50.0% 4.30 4.21
47.9% Interconnect 4.00 43.1% 40.0% 39.4% 3.50 30.0% Flash Radio ROM SRAM Memory 3.00 20.0%
2.50 10.0%
2.00 0.0% 2015 2016 2017 ASP Gross margin Source: ARM Source: Company data
NAND Flash Apart from NOR Flash, GigaDevice is ramping up NAND flash sales with a focus on the low- density, SLC (single level cell) 2D product segment. Its applications include embedded systems in feature phones, low-end smartphones, data cards, set-top boxes, and smart TVs. Its initial strategy behind entering the NAND market is to complement high-density NOR flash in high-end feature phones as the bit cost for NAND is more competitive in the 512Mb and above Flash memory category.
The market for NAND Flash amounts to USD47bn in 2017, which is much larger than for NOR Flash and MCU. However, due to high technical entry barriers the market is quite consolidated with the top five vendors (Samsung, Toshiba, Western Digital, Micron and SK Hynix) accounting for 93% market share in 2017.
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Exhibit 163. NAND Flash market size Exhibit 164. NAND Flash market share in 2017 50.0 47.2 60% (USDbn) 45.0 50% 40.0 Intel, 6% Others, 1% 40% 35.0 32.0 SK Hynix, 10% 28.2 28.8 30% Samsung, 30.0 27.5 36% 24.4 25.4 25.0 21.7 20%
20.0 10% 14.5 14.8 Micron, 12% 15.0 11.5 12.3 0% 10.0 -10% 5.0 Western 0.0 -20% Digital, 17% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Toshiba, NAND market size Yoy 17%
Source: Company data, HSBC Qianhai Securities Source: DramExchange
Global NAND bit demand has increased from 43bn GB in 2013 to 183bn GB in 2017, a CAGR of 62%. Rapid growth is likely to continue. Micron forecasts that NAND flash bit demand will rise at a 40-45% CAGR over 2017-21, driven by the proliferation of cloud data centres, high definition video, data storage, the growing transition from hard disk drive (HDD) to solid state drive (SSD) in PCs and servers, as well as growing storage density for mobile devices.
GigaDevice is able to provide SPI (Series Peripheral Interface) 1G-8G NAND with 1.8/3.0V voltage, and is in the process of extending this to 32GB. In terms of node technology, the company started mass producing 38nm NAND Flash in 3Q17, and is in the process of improving 24nm yield (over 40% yield in 3Q17). We estimate revenue from NAND flash will reach RMB50m in 2018, accounting for 2% of its total revenue.
However, we still see a big technology gap between GigaDevice and leading NAND flash suppliers. Their advanced 2D NAND node is generally at the 1xnm level, vs the 2x/3xnm offered by GigaDevice. They are also able to produce advanced 3D NAND. 3D NAND uses a stacked architecture, which means memory cells are layered vertically, in contrast to 2D NAND, which has a single layer. 3D NAND can pack more capacity into less physical space at lower cost than 2D NAND. 3D NAND normally uses MLC (multi-level cell) and TLC (triple-level cell) as it stores 2 and 3 bits per cell compared to SLC. It is essentially a solution to solve the bottlenecks in node shrinking under Moore’s Law.
SLC is now a niche market as it accounts for less than 5% of the total NAND market, with TLC capturing over 50% share, with the balance going to MLC. We think GigaDevice’s major competitors in SLC NAND include Taiwanese peers such as Macronix, Winbond, and Powerchip.
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Exhibit 165. NAND Flash bit demand Exhibit 166. SLC, MLC and TLC NAND growth comparison 800 703~809 (Bn Gb) SLC MLC TLC 700 Bits per cell 1 2 3 600 Writing speed Fastest 183 200 62% CAGR 100 43 0 2013 2017 2021 Enterprise & Cloud SSD Client SSD Mobile Consumer / removable Source: Micron Source: Speedguide.net Proposed acquisition of Shanghai Silead – eyeing AI and IoT opportunities GigaDevice wants to acquire a 100% stake in Shanghai Silead (unlisted) for RMB1,700m (RMB255m in cash and new share issuance of RMB1,445m). The placement price is fixed at RMB63.97/share, implying a total of 22.59m shares to be issued (8% of total outstanding shares). The transaction is now under review and subject to approval by the regulator, the CSRC. Silead is a leading Chinese IC design company that specializes in fingerprint and touch panel IC industry. It was ranked third in the fingerprint IC market in terms of shipments in 2017, with a 6.5% market share. It is also a top-five touch panel IC supplier worldwide with 9.5% market share. Around 50% of its revenue is generated from O-film Tech (002456 CH, CNY 17.24, Buy). In 2017, revenue totalled RMB448m, up 155% y-o-y, with 80% of revenue from fingerprint IC and 20% from touch panel IC. Thanks to the strong revenue growth, net profit also turned from a loss of RMB2.8m in 2016 to positive RMB11.4m in 2017. GigaDevice expects the acquisition will help the company to broaden its product portfolio to fingerprint and touch sensors. According to Sunrise Big Data, the fingerprint penetration rate in smartphones has increased from 26% in 2015 to 61% and is expected to reach 88% in 2020. In addition, we see an evolution in fingerprint technology from a traditional capacitive solution to optical (in-display) and ultrasound (under glass) which will continue to drive the adoption of fingerprint applications in the coming years. More importantly, GigaDevice intends to leverage on Silead’s expertise in biometric sensors and R&D platform in the areas of AI and IoT IC. In addition to the transaction cost, GigaDevice also plans to raise RMB1,075m via a private placement, mainly to invest in R&D. The focus will be on: 1) 14nm embedded AI Inferencing IC, to integrate voice, facial and biometric recognition technology; 2) the 30MHz ultrasonic MEMS sensor, which is targeting in-display fingerprint applications in smartphone and tablets; and 3) a human-machine interaction project. Given GigaDevice’s know-how in memory and MCU, we think it can become a total solution provider in SoC systems for AI and IoT. In addition, Silead has also guaranteed its aggregate net profit in 2018-20 to be no less than RMB320m. If it fails to achieve the target, the seller will proportionally return part of the shares received, based on the difference between actual and guaranteed profit. 89 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Exhibit 168. Revenue breakdown of Exhibit 169. Fingerprint industry market Shanghai Silead penetration 500 100% 91% 88% 450 2 85% 90% 82% 78% 400 87 80% 73% 70% 350 70% 61% 61% 300 60% 250 50% 43% 200 40% 1 358 30% 25%26% 150 20% 100 140 14 10% 50 63 34 0% 0 2015 2016 2017 2018 2019e 2020e 2016 2017 1Q18 Fingerprint IC Touch IC Others Global China Source: Company data Source: Company data, Sunrise Big Data Exhibit 170. 2017 fingerprint IC shipment Exhibit 171. 2017 capacitive touch IC market share shipment share Egis Tec Microarray Others Others 15% 3% 19% 12% Egis Tec 4% Goodix 35% Synaptics Cypress 4% 5% Mstar 14% Silead Chipone 7% 7% Betterlife Goodix FPC 8% 13% 35% Synaptics Silead 9% 10% Source: CCID, Company data Source: CCID, Company data DRAM the long-term driver: the Hefei project is making progress In October 2017, GigaDevice signed an agreement with Hefei Industrial Investment Group, a wholly owned subsidiary of Hefei SASAC, to jointly develop a 19nm, 12-inch DRAM project. The total investment amounts to RMB18bn. GigaDevice and the Hefei government are responsible for 20% and 80% of the total, respectively, through either direct or indirect equity or debt financing. The project aims to achieve more than 10% yield by end-2018. If the target is achieved GigaDevice has an obligation to acquire all the interests of Hefei Industrial Investment Group within five years. If the yield target is not realized, Hefei Industrial Investment Group has the right to ask GigaDevice to acquire its outstanding interest before the end of 2019. So far GigaDevice has not directly invested in the DRAM project, preferring financing through both debt and equity. Hefei Changxin is the primary entity for the DRAM project which started in 2016. So far GigaDevice does not have ownership of the project. The designed phase 1 monthly capacity amounts to 125,000 pieces. The company has recruited talent from leading memory companies in Taiwan, Korea, and Japan. Phase 1 plant construction was completed in in 1Q18 and the company has started equipment installation. There were over 1,500 employees as at April 2018, with approximately one third from Taiwan. 90 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Hefei Changxin has accumulated an impressive array of proprietary IPs over the past two years. By the end of 2017, the company had filed 354 patents and plans to apply for a further 1,155 in 2018. The technology covers the supply chain, including development tools, design, masks, fabrication, and testing. We believe it will take time to improve the yield from 10% to 60%, the level required for mass production. Once the 60% target is achieved, GigaDevice expects it will take another 8-12 months to reach an 80%-plus yield. GigaDevice now expects to mass produce 8GB LPDDR4 in 3Q19. On 17 July 2018, GigaDevice announced that its founder, Mr Zhu Yiming, had resigned as general manager but would remain as chairman and a board member. Deputy general manager, Mr He Wei, has taken over as general manager. At the same time, Mr Zhu was appointed as the CEO of Changxin Storage and Hefei Ruili Integrated Circuits, which are the two major subsidiaries under Hefei Changxin (see exhibit 173), according to report by technews.tw. More importantly, Hefei Changxin completed the design process for 8Gb LPDDR4 DRAM on 17 July. This suggests a critical milestone has been reached, creating an incentive for GigaDevice to ramp up its DRAM development. Exhibit 172. Key milestones of the Hefei Changxin DRAM project May 2016 Jan 2018 End 2018 3Q19 2020 Kicks off Complete phase 1 Sampling 8Gb To mass produce Start phase 2 DRAM project plant construction DDR4 8Gb LPDDR4 plant construction 2017 2018 2019 2020 2021 Mar 2017 Jan 2018 End 2019 2021 Starts Phase 1 Start equipment To reach To complete plant installation 20,000 R&D of 17nm construction pieces/month project Source: Company data Exhibit 173. Ownership structure of Hebei Exhibit 174. DRAM market size DRAM project 80.0 100% Hefei SASAC 72.8 (USDbn) 100% 70.0 80% Hefei Industrial Hefei Industrial GigaDevice Investment New Investment Group 60.0 1:4 Strategic Partners 60% 99.75% 0.25% 50.0 46.9 45.0 Hefei Ruijie 41.2 40% Hefei Changxin Jucheng 39.2 40.0 34.8 19.9% 80.1% 33.8 31.3 29.4 20% Changxin Storage 30.0 26.1 24.0 22.4 0% 100% 20.0 Ruili Integrated Circuit 10.0 -20% - -40% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 DRAM market size Yoy Source: Company data, Tianyancha.com Source: DramExchange, HSBC Qianhai Securities The size of the DRAM market increased 76% y-o-y to USD72.8bn in 2017, driven by a 46% y-o-y rise in selling price and 21% y-o-y bit growth. Propelled by growing demand from applications in data centers such as AI, autonomous driving, and increasing memory per device in smartphones and PCs, Micron forecasts that DRAM demand will increase from 92bn GB in 2017 to 190bn GB in 2021, a 20% CAGR over 2017-21. China relies heavily on DRAM imports as we estimate it consumes more than a third of global DRAM supply. In addition, DRAM supply is very concentrated with Samsung, SK Hynix and Micron 91 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 accounting for 95%. Given the rising DRAM price, high import value, and growing demand, we believe achieving DRAM self-supply is becoming a policy priority of the Chinese government. Unigroup Guoxin Microelectronics is the first Chinese company able to produce DRAM, but its products focus is on the DDR3 category. Fujian Jinhua, partners with UMC, focuses on 25 and 30nm node DRAM development. It completed plant construction and equipment installation in July 2018 and plans to mass produce in September 2018. That said, we think GigaDevice has the chance to be the technology leader among Chinese DRAM suppliers in 2019-20. Exhibit 175. Market share of DRAM in 2017 Exhibit 176. DRAM bit demand forecast 200 Winbond Powerchip 190 1% (bn Gb) 1% Others 180 Nanya 1% 2% 160 20% CAGR 140 120 Micron 21% 100 Samsung 92 46% 80 26% CAGR 60 36 SK Hynix 40 28% 20 0 2013 2017 2021 PC/Consumer Server Mobile Specialty Source: DramExchange Source: Micron, HSBC Qianhai Securities Forecasts and valuation Earnings forecasts We forecast that GigaDevice will record a 37% net profit CAGR over 2017-20e, driven by 39% revenue CAGR and stable margin. We believe NOR flash will continue to be an earnings driver and expect the company to improve its market share from 13% in 2017 to 23% in 2020e, especially in the mid- to low-density product category. We expect NOR flash to account for over 82% of its total revenue by 2020e, similar to the 84% in 2017. In addition, we expect NAND flash and MCU will achieve rapid revenue growth due to a low base and fast customer adoption. On the margin side, we expect gross margin to decline slightly due to potential pricing moderation on new capacity roll-out in China and competition with global peers. We do not factor in any revenue and earnings contribution from the Hefei DRAM project in our base case. 92 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Exhibit 178. Revenue and gross profit forecasts 2013 2014 2015 2016 2017 2018e 2019e 2020e 2017-20e Revenue (RMBm) CAGR Memory 782 829 1,062 1,292 1,716 2,350 3,478 4,744 40% NOR Flash 782 829 1,062 1,292 1,706 2,250 3,278 4,444 38% NAND Flash - - - - 10 100 200 300 211% MCU 1 15 127 197 311 451 586 703 31% Others 6 103 - - 3 2 3 3 0% Total 789 947 1,189 1,489 2,030 2,804 4,067 5,451 39% y-o-y 20% 26% 25% 36% 38% 45% 34% Gross profit Memory 172 232 290 313 645 870 1,252 1,708 38% MCU 1 6 50 85 149 203 264 317 29% Others - - - - 1 1 1 1 4% Total 173 239 341 398 795 1,073 1,517 2,026 37% Gross profit margin Memory 21.9% 24.9% 27.3% 24.2% 37.6% 37.0% 36.0% 36.0% MCU n/a 40.0% 39.4% 43.1% 47.9% 45.0% 45.0% 45.0% Total 21.9% 25.2% 28.7% 26.7% 39.2% 38.3% 37.3% 37.2% Source: Company data, HSBC Qianhai Securities estimates Sensitivity analysis We think global NOR flash shipment growth and GigaDevice’s NOR flash market share are the two critical swing factors for earnings. Our earnings sensitivity analysis for 2018e suggests that for every 5% difference in shipment growth, earnings would change by 3.8%; for every 2% difference in market share, earnings would change by 10.3%. Exhibit 179. Sensitivity analysis for 2018e earnings (RMBm) ______Global NOR flash shipment growth ______0% 5% 10% 15% 20% 13% 453 470 486 503 519 15% 504 523 542 561 580 GigaDevice NOR flash market 17% 555 576 598 619 641 share 19% 605 629 653 678 702 21% 656 683 709 736 762 Source: HSBC Qianhai Securities estimates Balance sheet and cash flow GigaDevice had net cash of RMB359m as at end-2017. The company has consistently generated positive operating cash flows since 2013 and positive free cash flow (except 2017), thanks to its asset-light fabless model. As the company is in the process of acquiring Shanghai Silead mainly via private placement, we think its balance sheet will remain solid in 2018-19. 93 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Exhibit 180. Balance sheet statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Cash and equivalents 199 262 420 872 587 551 796 1,228 Net receivables 57 116 136 129 173 230 334 448 Inventory/stocks 143 184 220 407 627 1,152 1,671 2,240 Other current assets 24 12 23 28 43 43 43 43 Total Current assets 423 574 798 1,435 1,431 1,977 2,845 3,959 Net PP&E/Fixed assets 37 35 47 76 102 216 320 411 Net intangibles 0 0 - 5 5 6 6 6 Total investments - 15 24 110 804 804 804 804 Other long-term assets 15 13 30 44 233 209 165 124 Total non-current asset 52 63 101 235 1,144 1,234 1,295 1,345 Total assets 475 636 900 1,670 2,574 3,211 4,139 5,304 Accounts payable 106 171 233 294 496 664 978 1,314 Short-term debt and - - - - 45 45 45 45 current portion of long- term debt Other current liabilities 1 9 13 23 13 13 13 13 Current liabilities 108 180 246 316 554 722 1,036 1,372 Long-term debt - - - - 184 184 184 184 Other long-term 35 36 83 74 80 142 184 240 liabilities/creditors Total long-term liabilities 35 36 83 74 264 326 367 424 Total liabilities 143 216 329 391 817 1,048 1,404 1,796 Common stock 75 75 75 100 203 203 203 203 Treasury stock - - - - (121) (121) (121) (121) Reserve 256 345 496 1,179 1,675 2,081 2,653 3,426 Other common equity ------Total common equity 331 420 571 1,279 1,756 2,163 2,735 3,508 Minority interest - 0 (1) 1 1 1 1 1 Total equity 331 420 571 1,279 1,757 2,164 2,736 3,508 Total liabilities and equity 475 636 900 1,670 2,574 3,211 4,139 5,304 Source: Company data, HSBC Qianhai Securities estimates 94 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Exhibit 181. Cash flow statement RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e Net income 67 98 158 176 397 542 763 1,030 Minority interest and 4 7 12 13 57 30 30 30 impairment add-back Depreciation and 15 17 20 25 31 36 46 59 amortization add-back Investment Loss (2) (5) (0) (1) (54) - - - (Increase)/decrease in 13 (22) 34 (130) (258) (414) (309) (347) working capital : Other operating cash flow 3 (0) (7) 1 25 - - - items Cash flow from 100 95 217 84 198 194 530 772 operations Capital expenditure (29) (18) (41) (79) (233) (150) (150) (150) (Acquisitions)/divestitures - - 0 - - - - - Investments (3) (6) (7) (83) (549) - - - Other investment cash - - 1 - - - - - flow items Cash flow from investing (32) (23) (47) (161) (782) (150) (150) (150) Dividends paid - (10) (15) - (53) (80) (135) (191) Share repurchase/issue - - - 535 121 - - - Increase/(decrease) in - - - - 235 - - - debt Other financing cash flow - - - (15) 9 - - - items Cash flow from financing - (10) (15) 521 313 (80) (135) (191) Effect of foreign (5) 1 3 9 (13) - - - exchange rate changes Total cash flow 64 63 158 452 (285) (36) 245 431 Free cash flow 71 77 176 5 (35) 44 380 622 Source: Company data, HSBC Qianhai Securities estimates Valuation We apply 12m forward PE to value GigaDevice, with reference to its historical valuation and earnings growth trend. We project the company will register 37% net profit CAGR in 2017-20e, which is slightly lower than historical CAGR of 44% during 2012-17. We believe it is reasonable to apply a historical average forward PE of 45.3x to value the stock. Accordingly, our target price for GigaDevice is RMB107.19, implying 3% downside. We rate the stock as a Hold. Upside risks Design wins in high-density, high-quality NOR Flash. GigaDevice’s current NOR flash products focus on the low-density category. If the company can win orders in the high-density segment for auto and industrial, it could boost the revenue and margin outlook from our base case. Higher-than-expected SLC NAND Flash revenue growth. SLC NAND Flash is a new business for GigaDevice, so it has a limited track record for this product. However, given the low base and its strategic partnership with SMIC, we do not exclude the possibility that GigaDevice could become a more competitive supplier in the 2D NAND market in the coming years. Downside risks NOR flash pricing and margin trend. Demand and supply dynamics will affect the NOR flash pricing outlook. Individual company capacity expansion/contraction, new applications and competition from other memory products will cause price volatility. Our base case assumes a flattish NOR flash price trend in 2018-20. Our sensitivity analysis indicates that a 1% change in the NOR flash price would potentially result in a 0.6% change in 2018e net profit. DRAM project development is slower than expected. There are various technical issues to be solved before commercial production can begin. If the company’s Hefei Changxin DRAM project fails to reach the development target on time as discussed above, GigaDevice is obliged to acquire all of 95 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Hefei Industrial Group’s interest in the DRAM development and may incur a significant loss on the project. Exhibit 182. Historical 12m forward PE Exhibit 183. Historical 12m forward PB 70.0 20.00 18.00 60.0 +1 STD 16.00 +1 STD 50.0 14.00 Mean 12.00 Mean 40.0 10.00 30.0 -1 STD 8.00 -1 STD 20.0 6.00 4.00 10.0 2.00 0.0 0.00 2016/9 2017/5 2018/7 2016/8 2017/1 2017/2 2017/3 2017/4 2017/6 2017/7 2017/8 2017/9 2018/1 2018/2 2018/3 2018/4 2018/5 2018/6 2017/2 2016/8 2016/9 2017/1 2017/3 2017/4 2017/5 2017/6 2017/7 2017/8 2017/9 2018/1 2018/2 2018/3 2018/4 2018/5 2018/6 2018/7 2017/11 2016/10 2016/11 2016/12 2017/10 2017/12 2016/10 2016/12 2017/10 2017/11 2017/12 2016/11 Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities 96 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Financials & valuation: Gigadevice Semiconductor Hold Financial statements Valuation data Year to 12/2017a 12/2018e 12/2019e 12/2020e Year to 12/2017a 12/2018e 12/2019e 12/2020e Profit & loss summary (CNYm) EV/sales 14.8 10.7 7.3 5.4 Revenue 2,030 2,804 4,067 5,451 EV/EBITDA 69.2 46.9 33.0 24.0 EBITDA 434 641 905 1,224 EV/IC 50.6 29.0 21.9 17.2 Depreciation & amortisation -31 -36 -46 -59 PE* 55.6 57.1 40.9 30.3 Operating profit/EBIT 403 605 859 1,165 PB 12.7 10.3 8.2 6.4 Net interest -27 3 3 4 FCF yield (%) -0.4 0.0 1.1 1.9 PBT 449 623 877 1,184 Dividend yield (%) 0.4 0.6 0.9 1.2 HSBC Qianhai PBT 449 623 877 1,184 * Based on HSBC Qianhai EPS (diluted) Taxation -52 -81 -114 -154 Net profit 397 542 763 1,030 HSBC Qianhai net profit 397 542 763 1,030 Issuer information Cash flow summary (CNYm) Share price (CNY) 110.00 Free float 73% Cash flow from operations 198 194 530 772 Target price (CNY) 107.19 Sector It Services Capex -233 -150 -150 -150 Reuters (Equity) 603986.SS Country China Cash flow from investment -782 -150 -150 -150 Bloomberg (Equity) 603986 CH Analyst Frank He Dividends -80 -135 -191 -258 Change in net debt 513 36 -245 -431 Market cap (USDm) 4,574 Contact +86 755 8898 3136 FCF equity -136 -1 335 577 Balance sheet summary (CNYm) ESG metrics Intangible fixed assets 5 6 6 6 Tangible fixed assets 334 425 485 535 Environmental Indicators Governance Indicators Current assets 1,431 1,977 2,845 3,959 GHG Intensity (kg/USD) na No. of board members 9 Cash & others 587 551 796 1,228 Energy Intensity (kWh/USD) na Average board experience (years) 2.2 Total assets 2,574 3,211 4,139 5,304 CO2 reduction policy Yes Female board members (%) 11.1 Operating liabilities 589 820 1,175 1,568 Social Indicators Board members Independence (%) 33.3 Gross debt 228 228 228 228 Net debt -359 -323 -568 -999 Employee costs as % of sales na Shareholders' funds 1,756 2,163 2,735 3,508 Employee turnover (%) na Invested capital 594 1,036 1,364 1,705 Diversity policy Yes Source: Company data, HSBC Qianhai Securities Ratio, growth and per share analysis Year to 12/2017a 12/2018e 12/2019e 12/2020e Price relative Y-o-y % change Revenue 36.3 38.1 45.1 34.0 160.00 160.00 EBITDA 169.1 47.6 41.2 35.3 140.00 140.00 Operating profit 194.9 50.0 42.0 35.6 120.00 120.00 PBT 141.8 38.7 40.8 35.0 100.00 100.00 HSBC Qianhai EPS -6.6 -2.6 39.4 35.0 80.00 80.00 Ratios (%) 60.00 60.00 Revenue/IC (x) 4.6 3.4 3.4 3.6 40.00 40.00 ROIC 80.1 64.6 62.3 66.1 20.00 20.00 ROE 26.2 27.6 31.1 33.0 0.00 0.00 ROA 19.9 18.6 20.7 21.7 2016 2017 2018 EBITDA margin 21.4 22.9 22.2 22.5 Gigadevice Semiconductor Rel to CSI 300 Index Operating profit margin 19.9 21.6 21.1 21.4 Source: HSBC Qianhai Securities EBITDA/net interest (x) 15.9 Net debt/equity -20.4 -14.9 -20.8 -28.5 Note: Priced at close of 03 Sep 2018 Net debt/EBITDA (x) -0.8 -0.5 -0.6 -0.8 CF from operations/net debt Per share data (CNY) EPS Rep (diluted) 1.98 1.93 2.69 3.63 HSBC Qianhai EPS (diluted) 1.98 1.93 2.69 3.63 DPS 0.39 0.67 0.94 1.27 Book value 8.67 10.67 13.49 17.31 97 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Disclosure appendix Analyst Certification The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Frank He Important disclosures Equities: Stock ratings and basis for financial analysis HSBC and its affiliates, including the issuer of this report (“HSBC”) believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise 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MCI (P) 016/02/2018 and MCI (P) 116/01/2018 [1101716] 101 HSBC Qianhai Research Team Head of Research, HSBC Qianhai Securities Steven Sun +86 755 8898 3158 [email protected] China Equity Strategy Analyst, Head of China Equity Strategy Research Steven Sun +86 755 8898 3158 [email protected] Associate Kate Zhang Consumer Analyst, Head of A-share Food & Beverage and Pulp & Paper Research Katharine Song +86 755 8898 3142 [email protected] Associate Joseph Zhou Healthcare Analyst, Head of Greater China Healthcare Research Zhijie Zhao +86 755 8898 3144 [email protected] Associate Jialei Fan Industrials and Environmental Services Analyst, Head of A-share Industrials and Environmental Research Bonan Li +86 755 8898 3139 [email protected] Telecoms, Media & Technology Analyst, Head of A-share Technology Hardware Research Frank He +86 755 8898 3136 [email protected] Analyst, Head of A-share Media & Internet Research Yi Guo +86 755 8898 3137 [email protected] Analyst, A-share Media & Internet Jing Han +86 755 8898 3147 [email protected] Analyst, A-share IT Software Jamie Ma +86 755 8898 3140 [email protected] Associate Kevin Xing Issuer of report: HSBC Qianhai Securities Limited Block 27 A&B, Qianhai Enterprise Dream Park 63 Qianwan Yi Road, Shenzhen-Hong Kong Cooperation Zone Shenzhen, China Telephone: +86 755 8898 3288 Website: https://research.hsbcqh.com.cn Main contributor Frank He* (S1700517120005) Analyst, Head of A-share Technology Hardware Research HSBC Qianhai Securities Limited +86 755 8898 3136 | [email protected] Frank He joined HSBC Qianhai Securities Limited in 2017 as Head of A-share Technology Hardware Research, covering the semiconductor, handset supply chain, telecom equipment and auto electronics sectors. From 2010 to 2017, he served as an analyst at two leading global brokerages, responsible for research on the clean energy, infrastructure and conglomerate sectors. In 2007-10, Frank was a lead technology and Internet research analyst at a Chinese securities firm in Hong Kong. He holds a BSc in actuarial science from the University of Hong Kong. *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations. 东西智库，专注知识分享