Credit Analysis of China's Technology Hardware and Semiconductor Manufacturers

Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers

November 26, 2020

ANALYSTS Key Takeaways Xiaoliang Liu, CFA ― The technology hardware and semiconductor sector has relatively high industry risk, Beijing +86-10-6516 6040 amid fast-paced advances in technology, cyclical downstream demand and intense [email protected] competition between players in the industry. Lianghan Wu ― Our sample of technology hardware companies is mainly composed of upstream Beijing manufacturers, core equipment suppliers and downstream consumer hardware +86-10-6516 6043 suppliers. In our view, these three types of companies generally derive their competitive [email protected] advantages from controlling cost, R&D strength and market influence respectively.

― We view that companies in the sector tend to use equity financing, and their financial leverage is generally low, putting the indicative financial risk profiles of most of the firms in our sample at a moderate or relatively low level.

Overview

This report aims to provide an overview of the process and methodology behind our analysis of technology hardware and semiconductors companies, through analyzing the business and financial metrics of technology hardware and semiconductors companies. The report also provides insight into the key drivers behind our analysis of technology hardware and semiconductors companies’ credit quality. By applying our corporate ratings methodology framework to public information, we have carried out a desktop analysis of 30 technology hardware and semiconductors companies, reaching an initial overview of the relative ranking of each company’s credit quality, or their “indicative issuer credit quality.” To better understand the relative position of each firm within the industry in terms of key metrics, we have also collected further data on a wider pool of 148 companies, including the 30 entities in our sample. By looking at the key business and financial data of these companies, we can observe the distribution of the key metrics within the industry. The distribution of indicative issuer credit quality among our sample of 30 entities is displayed in the chart below.

S&P Global (China) Ratings www.spgchinaratings.cn November 26, 2020 Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020

Chart 1 Indicative Issuer Credit Quality of 30 Sampled Entities No. of Companies

[AA] category & above [A] category [BBB] category [BB] category

Through this report, we use S&P Global (China) Ratings’ Corporate Methodology Framework to analyze the indicative issuer credit quality of relevant companies. When we analyze the credit quality of non-financial companies, we usually begin with analysis of the entity’s business risk profile and financial risk profile, and then look at the modifiers before arriving at its Stand-alone Credit Profile (SACP). We then analyze the external support that companies may obtain, including group or government support, to arrive at the Issuer Credit Rating (ICR). Unless stated otherwise, data in this report is calculated based on the weighted average of data from 2017 to 2019.

Chart 2

About This Article

S&P Ratings (China) Co., Ltd. (S&P China) has conducted a desktop analysis of a selection of entities, which we have chosen based on their asset sizes, representativeness of most regions and availability of public information. The analysis contained herein has been performed using S&P China Methodologies. S&P China Methodologies and analytical approaches are intended specifically for use in China only, and are distinct from those used by S&P Global

S&P Global (China) Ratings www.spgchinaratings.cn 2 Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020

Ratings. An S&P China opinion must not be equated with or represented as an opinion by S&P Global Ratings, or relied upon as an S&P Global Ratings opinion.

This desktop analysis has been conducted using publicly available information only, and is based on S&P China’s methodologies for corporates. The analysis involves a desktop application of our methodologies to public information to arrive at a potential view of credit quality across sectors. It is important to note that the opinions expressed in this report are based on public information and are not based on any interactive rating exercise with any particular entity. The opinions expressed herein are not and should not be represented as a credit rating, and should not be taken as an indication of a final credit rating on any particular entity, but are initial insights of potential credit quality based on the analysis conducted. This desktop analysis does not involve any surveillance. The opinions expressed herein are not and should not be viewed as recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security.

We have conducted this desktop analysis on individual corporates and present the results contained herein at an aggregate group level. The different sections of this research show the statistics and performance of different groups of entities and the market more broadly against the metrics we generally consider most relevant under our methodologies.

Given the desktop nature of this analysis, and that we have not conducted an interactive review with any particular entity, we may have made certain assumptions in lieu of confirmed information and where relevant we may also have attempted to consider any possibility of parent, group, government or other forms of potential support, to inform our view of potential credit quality. S&P China is not responsible for any losses caused by reliance on the content of this desktop analysis.

Business Risk Profile

In general, we assess a company’s business risk profile by combining our analysis of its industry risk and competitive position. We typically arrive at the latter by considering the company’s competitive advantages, scale, scope and diversity, operating efficiency, and profitability.

Industry Risk We view the technology hardware and semiconductor sector as a moderate high-risk industry (4), putting it at a mid-to-high level on our six-tier ranking. This reflects how growth prospects in the sector are impacted by three main factors: rapid advances in technology in the industry; strong cyclicality of downstream demand; and intense competition between technology hardware companies. In our view, demand for technology hardware and semiconductor manufacturers is highly cyclical and largely dependent on national economic growth, capital expenditure and IT hardware spending of key clients, fluctuations in demand caused by product innovation and technology upgrades, consumer confidence and motivation to purchase on credit Technology hardware and semiconductor manufacturers look to predict the demand cycle and gauge the direction of new technology, making corresponding investments in advance. This may widen the gap between production capacity and demand, further increasing product price volatility.

Competitive Position In our assessment of technology hardware and semiconductor companies' competitive position, we place particular emphasis on their competitive advantage. Companies with leading R&D capability and intellectual property as well as strong market acumen can improve their pricing ability and capacity to respond to cyclical fluctuations in the industry.

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At the same time, due to the diverse range of business models in this industry, we focus on different key areas when assessing the competitive position of companies in different subsectors. For companies directly facing end users, we focus more on the company's reputation or strength of its brand, product differentiation, and the ability of companies to respond to changes in market demand. Such companies are represented by Xiaomi. Processing and manufacturing technology hardware companies generally have capital intensive and tech- intensive business models. For such firms, including FII and BOE, operating efficiency is a key driver for gaining competitive advantage, alongside companies’ cost flexibility and cost control ability. In addition, some core equipment suppliers or technology solutions providers in the upper and middle reaches of the industry gain competitive advantage through strong investment in technology, which elevates their market share. R&D investment and the ability to produce leading technology are key to such firms maintaining their competitive position, as seen among companies like Huawei and Hikvision. The technology hardware and semiconductor manufacturers in our sample vary in terms of revenue scale, which is mainly due to the diverse range of subsectors in this industry and the large number of companies. These companies are present in upstream, middle, and downstream segments of each industrial value chain, with significant differences between their cost structure and business models as well as varied competition patterns. As shown in the chart below, the weighted average 2017-2019 revenue of the 30 technology hardware and semiconductor manufacturers in our sample varies widely from RMB 2.3 billion to RMB 759.1 billion. Among these firms, companies with very large sales are mainly big players with a significant impact on their industrial value chains, such as Huawei, FII and Xiaomi. However, most companies with smaller sales scale are manufacturing companies in the upper and middle reaches of the industrial value chain, such as IVO, Hytera and Huatian.

Chart 3 2017-2019 Weighted Average Revenue of 30 Sampled 800 Entities 700

600

500

billions 400 ， 300 RMB 200

100

Note:Ninestar uses 2018-2019 weighted average revenue. Source: Wind, S&P Global (China) Ratings. Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. Competitive Advantage We attach significant importance to technology hardware and semiconductor manufacturers’ competitive advantages. R&D capability and intellectual property are important starting points for gauging the competitive advantage of technology hardware companies. When taking the differences between subsectors into account, we also look at a firm’s brand reputation, strategic position, strengths in manufacturing or process technology and their relationships with clients. Other factors we consider include R&D cooperation, stability and dispersion of supplier channels, product positioning and pricing power and market share. Firms with such advantages often, in our opinion, are in the lead position for emerging technologies and have a significant influence on their industrial value chains, with the ability to turn these advantages into excellent financial performance.

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We view that companies with outstanding R&D and high R&D efficiency usually have competitive advantages over their peers. These companies can better grasp the trends and direction of technological development and develop their market and development strategies in advance, allowing them to adapt to fluctuations in the industry brought about by technological change. We usually consider the level of R&D investment of an entity against its peers, and look at the ratio of R&D to sales measured via R&D expenditure (including regular and capitalized costs) as a percentage of revenue. Among the 30 sampled entities, the R&D/sales rate of most firms is concentrated in a range of 0-10%, and only 2 companies account for more than 15%.

Chart 4 Distribution of Sampled Entities' R&D to Sales Ratio No. of Developers

As shown in the chart below, among our sample, companies with above-average R&D/sales ratios are mostly tech intensive firms, such as SMIC, Huawei and ZTE. Companies with lower R&D/sales ratios include Futong Group, Hengtong Group, Token Sciences and FII. In our view, differences in the R&D/sales ratio reflect the relative scale of R&D investment among the companies. Furthermore, subsectors have their own specific traits which affect R&D expenditure. Companies like Huawei and SMIC belong to more tech-intensive subsectors, while FII and Futong Group are in more capital intensive subsectors.

Chart 5 Ratio of R&D to Sales of Sampled Entities

Average Level

20%

10%

Note: Ratio of R&D to Sales = R&D Expenditure (including regular and capitalized costs) / Revenue. Source: Wind, S&P Global (China) Ratings. Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

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Higher R&D investment can enhance the pricing power and market position of technology hardware and semiconductor manufacturers. As shown in the chart below, we found that the growth rate of R&D expenditure among our sample correlates positively with the growth rate of operating revenue. Large-scale, mature players in the industry have relatively stable R&D expenditure and operating revenue growth. For firms undergoing rapid development, increasing R&D investment may be the key differentiator that enables them to boost their market share.

Chart 6

Revenue, R&D Expenditure Growth Rate of Sampled Numbers in the chart refer to： Entities 1 FII 2 Futong Group 80% 3 FiberHome

13 4 Goertek Group 60% 5 CVTE

9 16 19 6 Huawei 40% 18 15 4 20 14 29 27 7 Hikvision 2 7 3 5 8 Hentong Group 20% 25 17 11 9 Hytera 6 21 1 23 10 10 BOE 0% 8 11 JCET The Growth rateRevenue of 30 26 28 12 24 -20% 22 12 IVO -10% 10% 30% 50% 70% 13 Luxshare-ICT The growth rate of R&D expenditure 14 Lens 15 Leyard Source: Wind. 16 MLS Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. 17 Ninestar 18 OFILM R&D investment can help technical hardware and semiconductor manufacturers improve their pricing power. We have found that the R&D/sales rate of our sampled companies positively 19 Sunny Optical correlates to their gross profit rate as shown in the chart below. 20 SCC 21 Sanan 22 TCL Tech. 23 Tianma 24 Zhonghuan 25 Huatian 26 Token Sciences 27 Xiaomi 28 ZTE 29 Dahua 30 SMIC

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Chart 7 Numbers in the chart refer to： R&D Can Boost Companies' Pricing Power 1 FII 2 Futong Group 3 FiberHome 60% 9 4 Goertek Group 50% 7 5 CVTE 15 17 29 6 6 Huawei 40% 14 7 Hikvision 16 5 24 21 30% 20 12 8 Hentong Group

Gross Margin 26 28 19 25 3 30 9 Hytera 20% 13 8 10 BOE 4 1 10 10% 23 11 JCET 18 22 27 11 2 12 IVO 0% 13 Luxshare-ICT 0% 5% 10% 15% 20% R&D to Sales Ratio 14 Lens 15 Leyard Note: Bubble size represents R&D expenditure. Source: Wind, S&P Global (China) Ratings. 16 MLS Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. 17 Ninestar 18 OFILM In our analysis of R&D efficiency, we compare each company’s R&D expenditure to their number 19 Sunny Optical of R&D personnel and use that ratio as an important reference point. Most of our sample spend 20 SCC less than 500,000 RMB per R&D staff member. Only two firms in our sample spend more than one 21 Sanan million RMB per R&D staff member, namely SMIC and Huawei. 22 TCL Tech. 23 Tianma Chart 8 24 Zhonghuan Ratio of R&D Expenditure to No. of R&D Personnel 25 Huatian 26 Token Sciences Average Level 27 Xiaomi 2.0 28 ZTE 29 Dahua 1.5 30 SMIC

1.0

0.5 RMB, RMB, million/per person

0.0

Note: Certain companies in our sample have limited public information and are not shown on this chart. Source: Wind, S&P Global (China) Ratings. Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

In our view, gross margin also provides good insight into a company’s competitive advantage. This is mainly because gross margin can comprehensively reflect the competitive advantage of companies in terms of their intellectual property, R&D level, upstream and downstream pricing power, control of production and sales costs etc. In the chart below, the gross profit margin of our sample is mainly between 15% and 25%.

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Chart 9 Gross Margin Distribution of Sampled Entities No. of entities

Gross Margin

However, the differences between technology hardware and semiconductor manufacturers suggest that gross margin should be considered alongside other business and financial indicators for a more accurate reflection of a company's competitive advantage. For example, OEM firms have lower gross margins due to their business models. After considering the R&D capability, intellectual property and other factors pertaining to companies in this sector, we may still view them as having above average competitive advantage.

Chart 10 Gross Margin of Sampled Entities 50% Average Level

40%

30%

20%

10%

In addition, having long-term stable client relationships and R&D partnerships or a steady and wide range of supplier channels is another indicator of a company’s competitive advantage. In our view, the need to establish such stable and long-term relationships is a barrier to entry in the industry, and companies with such partnerships can also increase the switch cost of customers and client stickiness.

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Scale, Scope and Diversity We generally consider market share and supplier and customer concentration as well as diversity of end-markets, products and services when looking at technology hardware and semiconductor manufacturers’ scale, scope and diversity. In our opinion, technology hardware and semiconductor manufacturers with wider product lines and service coverage can generally choose from a greater selection of suppliers. Those companies with a more diverse manufacturing base can enjoy a broader customer base and reinforce the stability and sustainability of their operations. In our view, technology hardware and semiconductor manufacturers with above average scale, scope and diversity usually have leading market shares significantly higher than peers in fragmented markets, or the largest market shares in highly concentrated markets. These companies have diversified suppliers and production bases to ensure the stability of their supply chains and production. In addition, a well- diversified product line and a wide range of customer groups can also help a company maintain stable revenue scale in a rapidly changing market. Technology hardware and semiconductor manufacturers with below average scale, scope and diversity usually only have a certain market share in their own market segments, with limited supplier options, customers concentrated in specific groups and products concentrated in the same relevant market segments. For such firms, overall sales are very sensitive to fluctuating market demand. Concentration of suppliers and customers are important indicators we look at when considering the scale, scope and diversity of technical hardware and semiconductor companies. We view that a diversified customer base can greatly mitigate the risk of fluctuating downstream demand, and a diversified supplier and production base can ensure a stable supply chain and production. As shown in the chart below, companies with limited product lines and market segments have relatively high concentration, thus limiting their upstream and downstream pricing power. Companies with multiple product lines and better coverage along the industrial value chain have relatively low upstream and downstream concentration. Such entities have stronger upstream and downstream pricing power and are more resilient to risk.

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Chart 11

Concentration of Top Five Customers and Suppliers Numbers in the chart refer to： 1 FII

18 2 Futong Group 80% 3 FiberHome 1 26 13 4 Goertek Group 4 14 19 23 60% 5 CVTE 12 28 6 Huawei 20 30 7 Hikvision 10 40% 5 6 11 8 Hentong Group 16 21 Top 5 customers 9 Hytera 25 9 20% 27 10 BOE 22 17 3 29 11 JCET 15 7 0% 12 IVO 0% 20% 40% 60% 13 Luxshare-ICT Top 5 Suppliers 14 Lens Note: Certain companies in our sample have limited public information and are not shown on this chart. 15 Leyard Source: Wind, S&P Global (China) Ratings. 16 MLS Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. 17 Ninestar 18 OFILM Operating Efficiency 19 Sunny Optical We generally look at the operating efficiency of technology hardware and semiconductor 20 SCC manufacturers by considering their selling, general, and administrative (SG&A) costs and cost 21 Sanan structure. In addition, employee efficiency as measured by revenues/the total number of 22 TCL Tech. employees, capacity utilization and supply chain flexibility are also important indicators. 23 Tianma Companies with higher operating efficiency usually have: competitive overhead costs (measured 24 Zhonghuan via SG&A as a percentage of revenue); effective and flexible supply chains with a history of limited 25 Huatian disruptions or bottlenecks relative to peers when demand is high or following natural disasters; 26 Token Sciences flexible manufacturing capabilities that allow for better-than-industry-average capacity 27 Xiaomi utilization through the industry cycle, as well as efficient and timely product transitions in existing plants. 28 ZTE 29 Dahua For technology hardware manufacturers, we view having competitive overhead costs as a clear 30 SMIC marker of their operating efficiency. As shown in the chart below, manufacturers in our sample such as FII and Sunny Optical have lower SG&A rates, while the SG&A rates of communication equipment manufacturers is generally high. This may be due to rapid technological advances in the communication equipment industry, greater investment in research and development and higher downstream concentration.

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Chart 12 SG&A for Sampled Entities 30% Average Level

20%

10%

Note: SG&A=(sales expense+management expense)/operating revenue. Data used in this chart from 2018 and 2019. Source: Wind, S&P Global (China) Ratings. Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved.

In our view, turnover of current assets is another effective indicator for measuring operating efficiency in this sector. Through effective management of current assets such as inventory and accounts receivable, companies can speed up their cash flow conversion. Among our sample, CVTE, Futong Group, JCET and FII have significantly higher current assets turnover than the industry average.

Chart 13 Current Assets Turnover for Sampled Entities

Average Level 3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

In addition to the above indicators, we also consider revenue per employee (measured by revenue/the total number of employees). Most companies in our sample have revenue per employee of less than 2 million RMB. Xiaomi, Huawei and CVTE’s revenue per employee is significantly higher than the industry average, which shows that they are better at efficiently utilizing their staff.

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Chart 14 Revenue per Employee for Sampled Entities

Average Level 10

RMB, RMB, million/per person 2

Note: Certain companies in our sample have limited public information and are not shown on this chart. Source: Wind Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. Profitability In our view, profitability is the outcome of a company’s competitivity, scale, scope and diversity and operating efficiency. For technology hardware companies, we focus on the level of profitability and volatility of profitability in the mid to long term. We typically look at the firm's EBITDA margin, and consider their return on capital (ROC) and other indicators. After eliminating the influence of depreciation, amortization, different tax rates and financing costs, the EBITDA margin can reflect the company’s pricing ability and capacity for cost control. ROC takes into account the entity’s operating efficiency and management level and measures the firm's ability to generate returns by using debt and equity capital. The EBITDA margin of the 30 companies in our sample is mainly between 5% and 25%, as shown in the figure below.

Chart 15 EBITDA Margin Distribution of Sampled Entities No. of Entities

EBITDA Margin

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We have found that the EBITDA margin of technology distributors and OEM companies is significantly lower than other types of technology hardware and semiconductor companies. However, these companies can achieve ROC on a similar level as or even higher than companies in other subsectors through higher asset turnover. For example, the EBITDA margin of FII is low, but its ROC is far higher than the industry average.

Chart 16 EBITDA Margin of Sampled Entities

Average Level 50%

40%

30%

20%

10%

The ROC of our sample mostly ranges between 2% and 12%, but there are still 5 companies with ROC of more than 20%. Among them, despite its lower profit margin, FII’s operating efficiency is outstanding, and its capacity to control costs is very strong. Hikvision is the top player in the industry in terms of profit margin. In our view, the outstanding ROC of some hardware manufacturing companies shows that major players can obtain higher capital returns through establishing leading competitive positions in their own respective subsectors.

Chart 17 ROC Distribution of Sampled Entities No. of Entities

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Chart 18 ROC of 30 Sampled Entities 40% Average Level

30%

20%

10%

Financial Risk Profile

Our analysis of an entity’s financial risk profile mainly considers the coverage of its cash flow for debt and interest obligations. To measure the financial risk profile, we generally look at the company’s adjusted net debt/EBITDA ratio and funds from operations (FFO) to adjusted net debt We also look at EBITDA interest coverage ratio, FFO interest coverage ratio and other indicators for a more comprehensive measurement of firms’ financial risk profiles. In addition, we take into account the stability of past financial performance and future growth prospects. We found that technology and hardware companies have relatively lower debt levels, and the adjusted net debt of some companies is zero, such as Huawei, FII and Hikvision. As a result, the adjusted debt/EBITDA ratio in the industry is generally low. About 60% of companies in our wider sample of 148 entities have debt to EBITDA ratios of 2.5 times or less. Beyond the above metrics, when analyzing an entity’s financial risk profile we also consider other factors, including the company’s capacity for servicing long-term debt [(cash and cash-like assets + adjusted inventory + adjusted investment properties+ adjusted fixed assets + adjusted long term equity investment+ adjusted accounts receivables)/total debt] and servicing short- term debt [cash and cash-like assets/(short term debt + cash paid for payment of dividends, profits or interest obligations)]. Through looking at these two factors, we can gain a more comprehensive understanding of the company’s financial risk. On the following chart, we have plotted the long-term and short-term capacity of the 30 sampled entities to service their debt. At the same time, the horizontal lines indicate the average short- term debt coverage, and the vertical lines the average long-term debt coverage. We found that Huawei, FII, Xiaomi and Hikvision performed well for both short-term and long-term debt servicing.

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Numbers in the chart refer to： Chart 19 1 FII Technology Hardware and Semiconductor Companies' 2 Futong Group → Debt Servicing Capacity 3 FiberHome 4 Goertek Group 27 5 CVTE 6 6 Huawei 19 7 Hikvision 7 10 8 Hentong Group 30 1 25 13 15 9 Hytera 22 20 21 17

Higher 28 10 BOE 24 14 29 11 JCET 16 3 23 4 26 12 IVO term Debt Coverage (x, Logarithmic) 11 9 - 8 12 13 Luxshare-ICT 2 14 Lens 18 ←Short Lower ← Long-term Debt Coverage (x, Logarithmic ) → Higher 15 Leyard 16 MLS

Lower Lower Note: Horizontal lines represent upper and lower bounds of average short-term coverage, vertical lines represent upper and lower bounds of average long-term debt servicing capacity. Certain 17 Ninestar companies in our sample have limited public information and are not shown on this chart. 18 OFILM Source: S&P Global (China) Ratings. Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. 19 Sunny Optical 20 SCC 21 Sanan Distribution of Indicative Business and Financial 22 TCL Tech. 23 Tianma Risk Profiles 24 Zhonghuan 25 Huatian Based on the above analysis, we have arrived at the indicative business and financial risk profiles 26 Token Sciences of the companies in our sample, the distribution of which is shown in the charts below. As 27 Xiaomi technology hardware and semiconductor manufacturers typically have lower financial leverage, 28 ZTE the indicative financial risks of the sampled firms are generally at a moderate or relatively low 29 Dahua level. In terms of indicative business risk profile, most of the companies are at a satisfactory or 30 SMIC fair level.

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Chart 20 Numbers in the chart refer to： Distribution of Sampled Entities' Indicative BRP & FRP 1 FII 2 Futong Group

22 10 3 FiberHome 8 4 Goertek Group 17 5 CVTE 23 9 2 6 Huawei 4 18 7 Hikvision 11 14 8 Hentong Group Risk 28 16 3 12 9 Hytera 30 6 19 25 15 10 BOE

← Indicative FRP → Higher 13 11 JCET 1 20 21 5 12 IVO 27 26 7 13 Luxshare-ICT 29 Lower Risk 14 Lens Stronger← Indicative BRP →Weaker 15 Leyard Note: Bubble size represents 2017-2019 weighted average revenue. 16 MLS Source: S&P Global (China) Ratings. 17 Ninestar Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. 18 OFILM 19 Sunny Optical Other Rating Influences 20 SCC 21 Sanan 22 TCL Tech. The combination of business and financial risk profiles generally forms an anchor for us to gauge 23 Tianma the credit quality of an enterprise. On this basis, we apply and combine other factors relevant to the entity itself to arrive at our evaluation of the firm’s SACP. For technology hardware and 24 Zhonghuan semiconductor manufacturers, we pay particular attention to liquidity and management and 25 Huatian governance. 26 Token Sciences 27 Xiaomi When we look at liquidity, we generally consider whether sales proceeds for the next 12 months 28 ZTE and cash like assets would be sufficient to cover debt repayment, CAPEX, R&D expenses and 29 Dahua M&A investment. 30 SMIC Technology hardware and semiconductor companies usually have a high growth rate. In the process of development, companies tend to obtain the funds needed for development through the equity market. We focus on whether there is a Valuation Adjustment Mechanism (VAM) in place or equity dilution in the process of equity financing for these companies, which may result in controlling shareholders losing control and related risks. In addition, we also consider whether a firm’s internal governance structure and management level can keep pace with the scale required for a rapidly developing company.

Government and Group Support

After arriving at the companies’ indicative SACP, we also consider the influence of government or group support on their credit quality. When analyzing a group’s support for their technology hardware and semiconductor subsidiaries, we look at how closely the group’s main business is related to that of the entity, the position of the entity within the group’s future development strategy, and the amount of income and profit the entity brings to the group. We also pay attention to the extent of the group’s participation in the entity’s daily operations, management and appointment and removal of personnel, as well as the group’s previous support for the entity in terms of financial support and other factors. In addition, when analyzing the support of a privately-owned enterprise group for its subsidiaries, in addition to the above factors, we also consider whether the group has pledged its shares in technology hardware and semiconductor companies, and whether the group may be at risk of losing shareholder control of the company. For companies in sectors earmarked as key development industries by the state, we would expect them to have advantages in terms of R&D, financing, preferential tax policies and government

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subsidies. Such advantages can be reflected in the entity’s business and financial results, and can influence their rating anchor and SACP. For technology hardware and semiconductor manufacturers with a smaller proportion of government-related shareholders and ownership more dispersed among multiple minority shareholders, we pay particular attention to their external support. Besides enjoying the operational and financial advantages brought by their shareholders' backgrounds, whether such companies can get timely, full and effective support from relevant shareholders under special circumstances is an important factor that would affect the final credit quality of these companies.

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Appendix List of Sampled Companies

No. Entity Name Abbreviated Name

1 Foxconn Industrial Internet Co., Ltd. FII

2 Futong Group Co., Ltd. Futong Group

3 FiberHome Telecommunication Technologies Co., Ltd. FiberHome

4 Goertek Group Company Limited Goertek Group

Guangzhou Shiyuan Electronic Technology Company CVTE 5 Limited

6 Huawei Investment & Holding Co., Ltd. Huawei

7 Hangzhou Hikvision Digital Technology Co.,Ltd. Hikvision

8 Hengtong Group Co., Ltd. Hentong Group

9 Hytera Communications Corporation Limited Hytera

10 BOE Technology Group Co., Ltd. BOE

11 JCET Group Co., Ltd. JCET

12 InfoVision Optoelectronics (Kunshan) Co., Ltd. IVO

13 Luxshare Precision Industry Co., Ltd. Luxshare-ICT

14 Lens Technology Co., Ltd. Lens

15 Leyard Optoelectronic Co., Ltd. Leyard

16 MLS Co.,Ltd. MLS

17 Ninestar Corporation Ninestar

18 OFILM Group Co., Ltd. OFILM

19 Sunny Optical Technology (Group) Company Limited Sunny Optical

20 Shennan Circuits Co., Ltd. SCC

21 Sanan Optoelectronics Co.,Ltd Sanan

22 TCL Technology Group Corporation TCL Tech.

23 Tianma Microelectronics Co.,Ltd. Tianma

24 Tianjin Zhonghuan Electronic Information Group Co., Ltd. Zhonghuan

25 Tianshui Huatian Technology Co., Ltd. Huatian

26 Wuhu Token Sciences Co., Ltd. Token Sciences

27 Xiaomi Corporation Xiaomi

28 ZTE Corporation ZTE

29 Zhejiang Dahua Technology Co., Ltd. Dahua

30 Semiconductor Manufacturing International Corporation SMIC

Note: Companies listed in alphabetical order, based on pinyin name.

This report does not constitute a rating action.

S&P Global (China) Ratings www.spgchinaratings.cn 18 Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020

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S&P Global (China) Ratings www.spgchinaratings.cn 19