13 February 2017 | 8:08PM HKT Hong Kong Telecom Services: PCCW-HKT stake sale implications: Buy HKT’s 9% DPS CAGR at 7% yield Before market open on Feb. 13, PCCW announced that it (via wholly owned In Young Chung +852-2978-1171 | subsidiary CAS Holding) plans to dispose of an 11.1% stake in HKT Trust (HKT) via a [email protected] Goldman Sachs (Asia) L.L.C. secondary placement at HK$10.15 per share stapled unit, an 8.4% discount to the Piyush Mubayi Feb. 10 closing price. The consideration would be US$1.1bn based on the deal price. +852-2978-1677 | [email protected] We remain Buy on HKT given improving mobile and broadband fundamentals, and Goldman Sachs (Asia) L.L.C. also its robust dividend growth outlook. While our estimates are unchanged, in this note we look at key information about the deal as well as the potential implications for both companies. Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html . Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S. Goldman Sachs Hong Kong Telecom Services Key information & implications PCCW likely to remain as the major shareholder of HKT: While we do not take a view on the success of the secondary placement, PCCW’s stake in HKT would reduce to 51.97% from 63.07% post the placement, according to the announcement. Factors supportive of PCCW maintaining a majority stake in HKT: 1) HKT’s dividend (US$380mn in FY16) is still the most significant recurring source of cash for PCCW, and 2) 51% is the minimum stake PCCW needs to maintain in HKT to meet the terms of a historical agreement between PCCW and China Unicom (18.49% stake holder in PCCW) upon the listing of HKT in 2011 (any reduction below 51% would require China Unicom’s agreement). Implications for HKT: We remain constructive on the telecom fundamentals facing the company, including: 1) Mobile: We forecast HKT’s mobile postpaid ARPU to grow 3% to 4% per annum in 2017E-18E, driven by a rising mix of high ARPU customers, as the carrier began leveraging its superior network quality after completing the network integration (CSL and HKT) in 3Q16. Meaningful decline in mobile capex, post the completed network investment, is also likely to be a major tailwind for free cash flow, thus leading to dividend growth in our view. 2) Residential broadband: We believe Hong Kong’s residential broadband market has become even healthier, after Hong Kong Broadband Network (HKBN) accelerated subscriber gains in 2016, leading to a further solidified market structure with HKT and HKBN now collectively holding over 90% subscriber market share. 3) Dividend growth: As a result of the above, we forecast 9.4% DPS CAGR from 2016- 2018E. After today’s share price move (-7.4% to HK$10.26 as of the close), HKT generates attractive dividend yields of 6.8%/7.2% in 2017E/2018E, vs. the regional peer average of 3.3%/3.6% and its historical average of 5.7%. Implications for PCCW: As mentioned by management during its FY16 results briefing and stated in the public filing today, PCCW intends to use the proceeds of the 11.1% HKT stake sale to grow its core parent operations, IT Solutions and Media. Of note, on Feb. 6 PCCW announced it plans to dispose of its loss-making UK broadband asset for a US$300mn consideration. We highlight that visibility on profit for the two core businesses of PCCW has traditionally impacted the NAV discount against HKT. In our sum-of-the-parts valuation for PCCW, we apply a 40% NAV discount, 1 STD below the historical mean of 34%, reflecting profit uncertainties related to its new media businesses (OTT and FreeTV). Our Buy rating on PCCW is primarily driven by our constructive view on HKT (27% upside potential to our 12m TP), the most significant NAV driver of the PCCW share price (150% of NAV in our PCCW SOTP, pre-placement today). 13 February 2017 Page 2 Goldman Sachs Hong Kong Telecom Services Exhibit 1: Postpaid ARPU recovery to continue in 2017E HKT: Postpaid exit ARPU trend Source: Company data, Goldman Sachs Global Investment Research Exhibit 2: We project HKT’s DPS and dividend yield will continue to rise HKT: DPS (2015~2018E) and DY (2017E~2018E) forecast Source: Company data, Goldman Sachs Global Investment Research 13 February 2017 Page 3 Goldman Sachs Hong Kong Telecom Services Exhibit 3: 6.8%, 7.2% dividend yields for FY17E/18E after today’s dip in share price HKT: Forward dividend yield, US 10 year treasury bond yield, and the spread Source: Datastream, Goldman Sachs Global Investment Research Exhibit 4: 14.7X P/E (FY17E) is 1 STD below the 5 year average, despite +7.8% yoy EPS growth in FY17E HKT: 1-year rolling forward P/E history Source: Datastream, Company data, Goldman Sachs Global Investment Research 13 February 2017 Page 4 Goldman Sachs Hong Kong Telecom Services Exhibit 5: PCCW NAV discount Source: Company data, Goldman Sachs Global Investment Research Exhibit 6: PCCW SOTP valuation Source: Goldman Sachs Global Investment Research, Note: Pricing as of market close on Feb. 13, 2017. Pacific Century Property Dev. data based on Bloomberg consensus estimates. Valuation & Risks PCCW (0008.HK, Buy, HK$4.57 closing price as of Feb. 13): SOTP-based 12m target price of HK$5.50. Risks: Capital allocation uncertainties; HKT price. HKT (6823.HK, Buy, HK$10.26 closing price as of Feb. 13): DCF-based 12m target price of HK$13.00. Risks: Lower-than-expected ARPU growth; higher interest rates. 13 February 2017 Page 5 Goldman Sachs Hong Kong Telecom Services Disclosure Appendix Reg AC We, In Young Chung and Piyush Mubayi, hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Unless otherwise stated, the individuals listed on the cover page of this report are analysts in Goldman Sachs’ Global Investment Research division. Investment Profile The Goldman Sachs Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites of several methodologies to determine the stocks percentile ranking within the region’s coverage universe. The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows: Growth is a composite of next year’s estimate over current year’s estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatility adjusted for dividends. Quantum Quantum is Goldman Sachs’ proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can be used for in- depth analysis of a single company, or to make comparisons between companies in different sectors and markets. GS SUSTAIN GS SUSTAIN is a global investment strategy aimed at long-term, long-only performance with a low turnover of ideas. The GS SUSTAIN focus list includes leaders our analysis shows to be well positioned to deliver long term outperformance through sustained competitive advantage and superior returns on capital relative to their global industry peers. Leaders are identified based on quantifiable analysis of three aspects of corporate performance: cash return on cash invested, industry positioning and management quality (the effectiveness of companies’ management of the environmental, social and governance issues facing their industry). Disclosures Coverage group(s) of stocks by primary analyst(s) In Young Chung: Asia Pacific Telecoms, Korea Internet. Piyush Mubayi: Asia Pacific Telecoms, China Internet. Asia Pacific Telecoms: Advanced Info Service PCL, Astro Malaysia Holdings, Axiata Group, Chunghwa Telecom, Digi.com, Far EasTone, HKT Trust, Hong Kong Broadband Network Ltd., Indosat, Intouch Holdings, KT Corp., KT Corp. (ADR), LG UPlus, M1 Ltd., Maxis Bhd, PCCW Ltd., PT Link Net Tbk, PT Sarana Menara Nusantara, PT XL Axiata, Singapore Telecommunications, SK Telecom, SK Telecom (ADR), SmarTone, StarHub, Taiwan Mobile, Telekom Malaysia, Telekomunikasi Indonesia, Total Access Communications, Tower Bersama Infrastructure Tbk, True Corp. China Internet: 58.com Inc., Alibaba Group, Baidu.com Inc., Ctrip.com International, Gridsum, JD.com Inc., NetEase Inc., New Oriental Education & Technology, SINA Corp., TAL Education Group, Tarena International Inc., Tencent Holdings, Vipshop Holdings, Weibo Corp.. Korea Internet: Kakao Corp., Naver Corp., NCSOFT Corp.. Company-specific regulatory disclosures The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, “Goldman Sachs”) and companies covered by the Global Investment Research Division of Goldman Sachs and referred to in this research. Goldman Sachs has received compensation for investment banking services in the past 12 months: HKT Trust (HK$11.08) and PCCW Ltd.