China Smart Devices

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China smart devices

EQUITY: TECHNOLOGY

The next mega trend for 2014 and beyond? Global Markets Research

LTE, Smart Homes, 3D Vision, EV, IT nationalism, 21 May 2014

Smart TVs, 4G smartphones and more… Anchor themes Despite the macro slowdown and Industry view: hardware + service to stimulate industry upgrade saturation in major technology We believe “hardware + service” has become an important business model to product lines, we think innovation drive the development of China’s IT hardware sector. In the past two years, and policy supports are the popularity of WeChat and mobile gaming has accelerated adoption of 3G incubating a new round of smartphones in China. Since 2013, IPTV services such as LeTV have started growth, potentially benefiting to reshape China’s TV industry. Looking ahead, we believe: players well positioned in various  Mobile video services will stimulate growth of 4G smartphones TMT sub-sectors.

 TV game deregulation will become a new driver for Smart TVs in China Nomura vs consensus  Air pollution may boost demand for EV and green home appliances We analyse China's TMT industry  E-commerce will create new opportunities in O2O logistics from the perspective of a broad scope throughout the vertical &  Smart home hardware is ready to incubate service and reshape the industry horizontal axis, and across sub-  Concerns on IT security will benefit players in nationally strategic areas like sectors. semiconductor and enterprise equipment

Research analysts  3D vision may help machines to better understand the real world and innovate the way people use e-commerce and auto driving. China Technology Regulatory policies still matter Leping Huang, PhD - NIHK As well as the above, government policy will play an important role in guiding [email protected] the development of China technology and telecoms. In 2014, we think: +852 2252 1598  Information consumption is an important driver of 4G development David Hao - NIHK [email protected]  ‘Beautiful China’ and a new EV subsidy programme will drive EV adoption +852 2252 2153  Government funding and committee established to address the rising importance of national security for information, network equipment and IC

How to invest? We believe that some Chinese IT vendors (eg. Lenovo/Xiaomi in PC/Smartphones, Huawei/ZTE in telecom equipment, BYD in EVs and Haier/Gree in home appliances) are well positioned to transform their existing market share into profit if they can capture the growth opportunities that we explore in this report.

Fig. 1: Summary of relevant stocks listed in HK/China market Themes Relevant stocks in HK/China market ZTE (763 HK, top Buy), Huawei (unlisted), CCS (552 HK, Buy), Comba (2342 HK, Buy), 4G Capex Trigiant (1300 HK, NR) Digital China (861 HK, Reduce), Haier (1169 HK, NR), Gree (000651 CH, NR), O2O (online-to-offline) Midea (000651 CH, NR) Skyworth (751 HK, top Buy), TCLM (1070 HK, NR), LeTV (300104 CH, NR), Haier, Gree, Smart TV & Smart Homes Midea Electric Vehicle BYD (1211 HK, top Buy), Tianneng (819 HK, Buy), Chaowei (951 HK, NR)

3D Vision & Smart Drive Sunny Optical (2382 HK, top Buy), Truly (732 HK, NR) Lenovo (992 HK, Neutral), ZTE, SMIC (981 HK), Digital China, Kingdee (268 HK, NR), IT & Network Security ChinaCache (CCIH US), 21Vianet (VNET US) Lenovo, ZTE, Huawei, TCLC (2342 HK, Neutral), Coolpad (2369 HK, Neutral), BYDE (285 HK, Smartphone Value Chain Buy), Sunny Optical, Truly, Xiaomi (unlisted), AAC (2018 HK, Buy), O-Film (002456 CH, NR)

Source: Nomura research

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | China smart devices 21 May 2014

Contents

3 “Hardware + services” stimulate industry upgrades

4 Mobile video stimulates the growth of 4G smartphones

5 TV game deregulation to become second driver for Smart TVs

5 Air pollution drives EV adoption and green home appliances

6 E-commerce drives online-to-offline (O2O) logistics

7 Smart Homes: hardware is ready to incubate services

8 3D vision in e-commerce and driving

9 Regulatory changes in China

9 Which are the largest IT hardware companies in China?

11 How to invest?

12 Our top picks

13 What are the structural trends ahead?

13 How big will 4G and export markets be in 2014?

18 Smart Homes: a bigger market than smartphones?

24 Smart TVs: service market starts to take off

27 Information security and IT nationalism

31 Electric Vehicle: How do you have a beautiful China without some green cars?

36 3D vision and smart drive

41 Links to our recent reports

42 Stocks fall into the themes

43 China Technology industry forecast summary

44 Industry value chain charts

49 Appendix A-1

Nomura | China smart devices 21 May 2014

“Hardware + services” stimulate industry upgrades We believe “hardware + service” has become an important business model to drive the development of China’s IT hardware sector. As highlighted in our 2013 report, China smart devices - What will be the next mega trend?, the innovation in consumer electronics has shifted from smartphone to TV in 2013. We expect this shift will continue in 2014 and expect new innovation to come from home appliances (Smart Home), automobiles (new energy vehicles and smart drives) and e- commerce (3D shopping). In addition, we see the rising importance of regulation such as information security and air pollution control, which will accelerate the growth of enterprise equipment and new energy vehicles, in our view.

Fig. 2: Service innovation in China drives hardware upgrades

2010~ WeChat +=

2013~ LeTV +=

2013~ + =

Made in China

2014~ + =

2014~ +=

Source: Nomura research

Nomura | China smart devices 21 May 2014

Mobile video stimulates the growth of 4G smartphones In the past two years, the popularity of WeChat and mobile gaming has accelerated the use of 3G smartphones in China. As illustrated in the charts below, WeChat MAU reached 396mn subscribers (32% mobile subscriber penetration rate) at end-1Q14, vs. 461mn 3G subscribers (37% penetration rate) at end-1Q14, showing growth clearly outpacing that of overall 3G services. In our opinion, the growth of WeChat’s subscriber base and the upgrade in WeChat services are important drivers for China’s 3G smartphone growth. For example, new features in the WeChat platform include areas such as acoustics, maps/GPS, cameras as well as touch panels and Near Field Communication (NFC). Looking forward, the key question is what will be the killer applications for 4G services in China. We believe mobile video services such as iQiYi and Youku may become important drivers to stimulate 4G migration. Looking at the mobile market in China, according to iResearch, mobile video daily average users (DAU) reached 6.22mn in Dec 2013, increasing 148% y-y from 2.51mn in Dec 2012. At the same time, the monthly total mobile video viewing time increased to 119mn hours in December 2013, up 298% y-y from same period in 2012 (30mn hours). Thus, we think the explosive growth in demand for traffic-heavy mobile services such as video will ultimately fuel the demand for faster smartphones and a faster network from both consumers and operators for reasons such as better user experience and cost savings.

Fig. 3: WeChat subscriber growth has outpaced 3G Fig. 4: Explosive growth in mobile video DAU and viewing subscriber growth in China time in China

(mn subs) (mn users) DAU (LHS) (mn hours) 500 WeChat MAU (RHS) 40% 7 Hours/month (RHS) 140 3G Sub.(LHS) 35% 6 120 400 WeChat Penetration (RHS) 30% 5 100 3G Penetration (RHS) 4 80 300 25% 20% 3 60

200 15% 2 40

10% 1 20 100 5% 0 0

0 0% Jul-13 Apr-13 Oct-13 Oct-12 Jun-13 Jan-13 Feb-13 Mar-13 Aug-13 Sep-13 Nov-13 Dec-13 Aug-12 Sep-12 Nov-12 Dec-12 1Q12 3Q12 1Q13 3Q13 1Q14 May-13

Source: Company disclosure, Nomura research Source: iResearch, Nomura research

At the same time, even IM services such as WeChat are evolving, introducing more services (eg. location sharing, GPS, video calls, etc) that will not only increase data consumption, but also require the network speed and latency to be faster.

Fig. 5: Illustration of WeChat’s roadmap

Ver. 3.0 Ver. 4.0 Ver. 5.0 Ver. 1.0 Ver. 2.0 Location Video call, Game, Test Voice based photo payment, message message social sharing O2O network

Touch Screen Smartphone Acoustics Map & GPS Camera Quad-core NFC Acoustics Camera

Source: Nomura research

Nomura | China smart devices 21 May 2014

TV game deregulation to become second driver for Smart TVs We have noticed a boom in the launch of TV game consoles since the beginning of 2014. Products include Huawei’s game console launched during MWC with Perfect World, ZTE’s FunBox launched with The9 cities in March 2014, Microsoft’s Chinese version of XBox jointly developed with BesTV (600637 CH, NR), and TCL’s T2 launched together with Gameloft in April 2014. We believe this boom is triggered by two things. First, the Chinese government reversed its 14-year ban on dedicated-purpose game consoles (eg, Xbox, Nintendo Wii, PS4), which was in place since 2000. Second, it is driven by the availability of Android-based games and software platforms which greatly lower the incremental cost to develop games for multiple platforms (eg, smartphones, TVs and PCs). Although there are still some regulatory restrictions such as the pre-approval requirement for game titles, we think this will become a new driver of Smart TV sales, and benefit TV vendors like TCL Multimedia and Skyworth in terms of recurring contents revenue.

Fig. 6: XBox in China Fig. 7: TCL T2

Source: Nomura research

Air pollution drives EV adoption and green home appliances Pollution has become a serious problem in China along with industrialisation in major cities. The government’s latest view on environment protection is to find the quickest and easiest way to effectively reduce levels of pollution, and all eyes are on vehicle licensing controls and promotion of pure/hybrid EVs. Fine particulate matter (PM 2.5) refers to tiny particles in the air that are two and a half microns or less in width, which can travel deep into the respiratory tract to the lungs. Long-term exposure can lead to health conditions including asthma and heart disease. Major sources of PM 2.5 in China’s cities, particularly Beijing, include cooking, industrial pollution, vehicles and dust; among these, vehicles are the largest source, contributing 40-50% of the PM 2.5 in the air.

Nomura | China smart devices 21 May 2014

Fig. 8: Example of polluted air in Beijing due to PM2.5 Fig. 9: Beijing’s PM2.5 index trends Beijing's CCTV building peeking through the haze (14 Jan) Above 50 is unhealthy; above 150 is very unhealthy PM 2.5 Index 350

300

250

200

150

100

Source: news.cn, Nomura research

Source: Nomura research

Vehicles are the largest source of PM 2.5; the Chinese government has rolled out numerous incentives to contain vehicle pollution, which in turn should help to accelerate EV adoption in China, in our view.

E-commerce drives online-to-offline (O2O) logistics According to iResearch, the online shopping market has taken off over the past six years, with a 71% CAGR to reach CNY1.86tn in gross merchandise volume (GMV) in 2013, from CNY0.13tn in 2008. At the same time, O2O GMV took off in 2011 and grew 13x over two years from CNY13bn in 2011 to CNY183bn in 2013. From 2013 to 2016, iResearch forecasts online shopping and O2O will grow at 38%/115% CAGRs to reach CNY4.89tn/CNY1.83tn, respectively. This rapid shift in consumer buying behaviour is nurturing the growth of a brand-new logistics business to efficiently handle e-commerce-related inventory distribution and product/service delivery. China’s e-commerce giants have taken aggressive steps to develop their logistics platforms. • Alibaba’s investment in Haier and Cainiao On 9 December 2013, Alibaba (unlisted) made a CNY2.8bn strategic investment in Haier Electronics Group. The investment focused on Goodaymart (unlisted), Haier’s logistics subsidiary for large items. Through the investment, Haier and Alibaba aim to build a logistics platform dedicated to e-commerce-driven home appliance purchases. In May 2013, Cainiao was formed, led by Alibaba (e-commerce), Yintai (property/retail), Fosun (property/retail), Shunfeng Express (Logistics) and five other companies with the intention to build a nationwide integrated warehouse, inventory management, and logistics centre for e-commerce. Planned investment is CNY300bn in the next 5-8 years. • JD.com and others In addition to Alibaba in 2013, JD.com announced a CNY3.5bn investment in a logistics centre; Yixun.com (subsidiary of Netease, NTES US, NR) plans to build more than 10 distribution centres in China; and Suning plans CNY20bn capex to build logistics centres in the next three years.

Nomura | China smart devices 21 May 2014

Fig. 10: Rapid growth of e-commerce (measured in GMV) Fig. 11: Comparison of online-offline cost structure in TV

(CNYtn) LeTV Skyw orth 6 Online shopping (LHS) 500% S40 Coocaa 42E7DRS O2O (LHS) Sales channel Online Online Offline 5 Model 40-inch 42-inch 42-inch Online shopping y-y (RHS) 400% TV hardw are 1,999 2,999 3,999 4 O2O y-y (RHS) 300% Mandatory 1-yr Subscription Fee 499 - - 3 Total revenue 2,498 2,999 3,999 200% COGS 2,373 2,729 2,729 2 Gross profit 125 270 1,270 100% GPM (%) 5% 9% 32% 1 Sales, Marketing and Other OPEX 148 222 923 0 0% Markup (%) 8% 8% 30% Operating Profit (23) 48 347

2008 2009 2010 2011 2012 2013 % of sales ‐1% 2% 9% 2014F 2015F 2016F

Source: iResearch, Nomura research Source: Company data, Nomura estimates

Smart Homes: hardware is ready to incubate services After PCs and smartphones, the trend towards “smart” is just beginning as people start to experiment making everything else “smart”, in a world of M2M. Besides PCs and smartphones, home appliances, wearable devices, and vehicles are next in line. Smart Appliances prepared to make an impact as standalone hardware From our visits to China’s leading home appliance vendors, all of Haier, Gree, and Midea are making aggressive moves to adopt “smart” in their products. Although we agree with Gree’s view that it is maybe still too early to define smart homes on a service level and monetize from it, we do believe that on the hardware level smart home appliances are ready to make an impact in areas of energy saving and user-friendly controls. For example, smart air purifiers and air conditioners that constantly monitor home environments and learn from the home owner’s daily patterns may act intelligently to always provide a most comfortable environment for its users, especially important in China where people would love to at least keep air quality under control in their homes. Not yet ready on a service and eco-system level We think it will take more time to build a mature eco-system where new services and business models can be tried and monetized – much like in the early days when the iPhone was launched, where it took a couple of years for the applications/service community to become more creative and introduce killer applications.

Fig. 12: Smart home products as a % of total sales Fig. 13: Haier Air Box

Smart home Traditional products 100%

80%

60%

40%

50% 20% 30% 5% 15% 0% FY14F FY15F FY16F FY18F

Source: Midea, Nomura research

Source: Nomura research

Nomura | China smart devices 21 May 2014

3D vision in e-commerce and driving 3D vision and e-commerce We believe there are large potential applications for 3D vision beyond handsets including game consoles and gesture control applications (eg, Leap Motion). There are currently many pilot programmes at major Internet companies worldwide, the most famous ones being Google’s Project Tango and Amazon’s 3D smartphone. We find Ebay’s efforts to bring 3D vision to the e-commerce space very interesting. Ebay (EBAY US, NR) acquired PhiSix (unlisted) recently to let online shoppers virtually "try on" jeans, dresses, shirts, and other clothing to see how they fit and look in an online environment (shown in the figure below). 3D vision and vehicles Auto makers and their suppliers are actively working with internet companies to make vehicles “smarter”. We think it is a gradual process starting from enhancing external sensors, to introducing driver-system interaction in the cockpit, to partially freeing up drivers with intelligent driving assist functions, to ultimately freeing up drivers completely with intelligent auto drive. From a hardware perspective, we are observing several trends, including 1) more sensors inside and outside of a vehicle (eg, cameras, infra-red, motion detectors, etc); and 2) larger panels (eg, central displays are growing from ~5-inches to 7-inches+). From a software/service perspective, we are observing the development of interactive services (eg, OS, apps, and alternative controls including voice and gesture), by companies such as Tencent, Google, and Apple with auto makers; in addition, we are also observing cooperation between auto makers and third companies (eg, insurance providers) to jointly introduce services based on big data.

Fig. 14: Intelligent auto drive Fig. 15: 3D virtual clothes The shopper scans herself to create a virtual model to try on different virtual clothes also scanned to determine the fit and look

Source: Bing.com

Source: Nomura research

Nomura | China smart devices 21 May 2014

Regulatory changes in China • Information consumption drives 4G development in China In July 2013, the State Council decided to promote “information consumption” as part of China’s national strategy in economic transformation, and TD-LTE is one important part to this strategy to stimulate the consumption of mobile Internet services and smartphone hardware. On 14 August, the State Council published “Opinions on information consumption boosting domestic demand” (关于促进信息消费扩大内需的若干意见). The document indicates that information consumption is a catalyst in creating domestic demand, upgrading the service industry and promoting economic transformation. • “Beautiful China” driving electric vehicle adoption China’s government announced its new subsidy standard for new electric vehicles in September 2013, which prioritized electric buses to resolve air pollution problems. We believe the focus on buses is in line with the government’s policy “Beautiful China” (Dec 2012) and “Action Plan for Air Pollution Control” (Sep 2013) to replace conventional vehicles with clean energy vehicles (LNG cars) and new electric vehicles to resolve the air pollution problems. By 2017, the government targets to: 1) reduce the concentration of inhalable particles (IP) by >10% vs. 2012; 2) reduce the concentration of fine particles by 25%/20%/15% for Jing-Jin-Ji (京津冀), Yangtze River Delta and Pearl River Delta regions, respectively; and 3) control the full-year average concentration of fine particles in Beijing at ~60mcg/m3. • PRISM drives server and IC upgrades We see a clear trend to promote the adoption of domestic equipment and components since mid-2013 after media reports about the US surveillance program PRISM. In November 2013, China established the National Security Committee (NSC, 国家安全委员会) which is chaired by China President Mr. Xi Jinping. NSC’s mission includes: • Strengthen regulatory oversight of the internet (加大依法管理网络力度), • Accelerate the institutional establishment of an internet management system (加快完善互联网管理领导体制), • Secure the safety of national networks and information (确保国家网络和信息安全). We think semiconductor and network equipment are two areas which are critical to the whole IT infrastructure, but Chinese vendors still lag behind in terms of market share, which may potentially turn into opportunities for Chinese players to grow.

Which are the largest IT hardware companies in China? From a revenue perspective, Huawei is China’s largest IT vendor, backed by its No.2 position in telecom equipment sales. Haier has the second largest revenue, propelled by its complete product portfolio in home appliances. Then Lenovo is a close third, behind its No.1 position in PCs, then Gree with its No.1 position in Air conditioners. After Lenovo completes the acquisition of IBM’s x86 business and Motorola, it will become the largest IT vendor in China by revenue in 2014. On the profit side, Huawei was the most profitable IT vendor in China in 2013, with net profit of CNY21bn at a NPM of 8.8%, thanks to its technology leadership in the telecom equipment space. This is followed by Gree’s 9% NPM and CNY11bn in net profit backed by its in-sourcing of key components in air conditioners like compressors and its vertically integrated business model. However, if we compare Huawei/Gree with leading international consumer electronics vendors like Samsung, Huawei/Gree’s profits are still only 13%/7% of Samsung’s currently.

Nomura | China smart devices 21 May 2014

Fig. 16: Comparison of revenues (2013) Fig. 17: Comparison of net profits and net margins

(CNYbn) (CNYbn) Net Profit (LHS) 300 25 Net Profit Margin (RHS) 10% 239 250 20 8% 200 180 179 15 6% 150 120 121 93 10 4% 100 86 75 5 2% 50 30

0 0 0% ZTE TCL TCL ZTE Gree Haier Gree Haier Midea Midea Lenovo Huawei Lenovo Huawei HiSense HiSense Skyworth Skyworth

Source: Company data Source: Company data

Fig. 18: Comparison of major global TMT companies

(CNYbn) Revenue (LHS) Profit (LHS) Profit Margin (RHS) 38.0% 1,600 40% 1,370 1,400 30.3% 1,200 1,051 30% 1,000 19.3% 20.5% 800 20% 630 13.3% 600 400 10% 215 183 200 122 60 18 46 18 0 0% China Mobile Apple Samsung Tencent Alibaba

Source: Company data, Nomura research

China has the world’s second-largest GDP, but none of the Chinese vendors are ranked within the top-100 consumer brands currently according to InterBrand. From a top-down perspective, if any of the Chinese IT brands can increase their global brand value, this will help them to enjoy margin premium and margin expansion, and help them transform their market share into profit. We believe Lenovo/Xiaomi in PCs/Smartphones, Huawei/ZTE in telecom equipment, BYD in electric vehicles, and Haier/Gree in home appliances are in a good position to transform their existing market share into profit if they can capture some of the growth opportunities we highlight within this report.

Nomura | China smart devices 21 May 2014

Fig. 19: While Chinese consumer electronics vendors are big, they are not well known in the market

Top 10 Smartphones (4Q13) Top 10 PCs (1Q14) Top 10 LCD TVs (4Q13) Global brand ranking Rank Company Share Rank Company Share Rank Company Share 2013 2012 Company 1 Samsung 29.5% 1 Lenovo 17.7% 1 Samsung 23.1% 1 2 Apple 2 Apple 17.8% 2 HP 17.2% 2 LGE 13.7% 2 4 Google 3 Huaw ei 5.7% 3 Dell 13.5% 3 Sony 6.4% 5 5 Microsoft 4 Lenovo 4.6% 4 Acer 7.0% 4 TCL 5.8% 8 9 Samsung 5 LG Electronics 4.5% 5 ASUS 6.3% 5 Hisense 4.2% 57 19 Nokia 6 ZTE 4.0% 6 Apple 5.4% 6 Changhong 4.0% 19 20 Amazon 7 Sony 3.6% 7 Toshiba 5.0% 7 Skyw orth 3.9% 46 40 Sony 8 Coolpad 3.0% 8 Fujitsu 2.4% 8 Panasonic 3.8% 68 65 Panasonic 9 Nokia 2.9% 9 Samsung 2.3% 9 TPV/AOC 3.7% 28 36 eBay 10 TCL Com 2.6% 10 Sony 1.5% 10 Toshiba 3.6% n/a 93 Blackberry Others 21.8% Others 21.7% Others 27.8% Total Chinese 19.9% 17.7% 21.6%

Source: Gartner, IDC, DisplaySearch, Interbrand

Fig. 20: Who will become the next Samsung?

Population GDP # of tech brand Country in top 100 (mn) (USD tn) brands

Apple Google IBM Microsoft GE And 11 more… 314 14.99 16 No.1 No.2 No.4 No.5 No.6

Canon Sony Nintendo Panasonic 128 5.8 4 No.35 No.46 No.67 No.68

Samsung 50 1.1 1 No.8

1344 7.3 0

Source: Interbrand, Nomura research

How to invest? Looking forward, we expect a slowdown in demand for most consumer electronics in China due to the macro slowdown and demand saturation in major product lines. However, we also note that some Chinese IT vendors (eg, Lenovo/Xiaomi in PCs/ Smartphones, Huawei/ZTE in telecom equipment, BYD in EVs, and Haier/Gree in home appliances) are in a good position to reap profits, if they can capture the growth opportunities we highlight in this report.

Nomura | China smart devices 21 May 2014

Fig. 21: Company exposure to investment themes in 2014

4G 3D Information Air Pollution e-commerce 4G CAPEX Smartphones Smart TVs Smart Home Vision/Smart Security & IT & EV & Logistics Ticker Company Names Rating and Exports Drive Nationalism

992 HK Lenovo NEUTRAL 20% Small Small Small 20% 552 HK CCS BUY 65% 981 HK SMIC NEUTRAL 45% 30% 1211 HK BYD BUY 30% 763 HK ZTE BUY 40% 25% Small 10% 285 HK BYDE BUY 100% 2382 HK Sunny Optical BUY 70% Small Small 15% 2369 HK Coolpad NEUTRAL 100% 2342 HK Comba BUY 80% 861 HK Digital China REDUCE 20% 60% AMAP US AutoNavi BUY 70% 2342 HK TCL Com NEUTRAL 100% 751 HK Skyworth BUY 80% 20% 1070 HK TCL Multimedia NR 80% 20% 819 HK Tianneng BUY 100% 951 HK Chaowei NR 100% 732 HK Truly NR 100% 941 HK China Mobile NEUTRAL large Small 762 HK China Unicom BUY large Small 728 HK China Telecom NEUTRAL large Small 1169 HK Haier NR 30% 60% 000651 CH Gree NR <5% 95% 000333 CH Midea NR <5% 95% 382 HK Welling NR 100% 1300 HK Trigiant NR 100% 633 HK China All Access NR 70% CCIH US ChinaCache NR 15% 15% 20% 20% VNET 21Vianet NR 15% 15% 20% 20%

Source: Nomura estimates

Our top picks We select BYD (electric-vehicle), Sunny Optical (3D vision & smart drive), Skyworth (Smart TV/Home), ZTE (telecom equipment & 4G capex) as our top picks in their respective space. • BYD (1211 HK, Buy, TP HKD64): based on SOTP valuation and assign different EV- to-sales ratio by business segment. This implies 49x FY15F EPS of CNY1.04, within its historical trading range of 10-68x. BYD has already shown strong growth in EV in 1Q14, capturing ~30% market share, and is on track to deliver its EV target. • Sunny Optical (2382 HK, Buy, TP HKD10): based on 14.5x FY14F EPS of HKD0.59; the multiple is a 20% discount to peer Largan’s target P/E of 18x. We are confident about Sunny’s ability to maintain above 30% earnings growth in 2014F, driven by handset lens set, vehicle lens, and non-handset camera module businesses. March and Aprils shipment data is already confirming our view. • Skyworth (751 HK, Buy, TP HKD6): based on 9x FY15F EPS of HKD0.62. We believe TV shipment growth will recover starting in June 2014 and the company is set to delivery strong growth from its white-appliances business. • ZTE (763 HK, Buy, TP HKD20): based on 20x FY14F EPS of CNY0.81 to reflect improving visibility on margin recovery and 4G capex. We have already observed strong turnaround in margin and earnings in 4Q13 and 1Q14 and believe the trend will continue, benefiting from China’s strong 4G capex in 2014-16.

Nomura | China smart devices 21 May 2014

What are the structural trends ahead?

How big will 4G and export markets be in 2014? After two years of rapid growth, China’s smartphone market finally entered an adjustment period in 1Q14. According to China Academy of Telecom Research (CATR), MIIT’s research institute, China’s total smartphone/handset shipments fell 9%/24% y-y respectively in 1Q14, which is the first ever y-y smartphone shipment decline in China, and also the first y-y decline of handset shipments since 2Q12. According to Gartner, China’s smartphone shipments grew 58% y-y in 4Q13, but the growth rate was down from 91% in 3Q13 and 104% in 4Q12.

Fig. 22: China smartphone sales pull back in 1Q14 Quarterly smartphone shipment volume forecasts (mn units) Shipments (Gartner) (LHS) Shipments (CATR) (LHS) 160 300% Growth (CATR) (RHS) 140 120 200% 100 80 100% 60 40 0% 20 0 -100% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14F 3Q14F 4Q14F

Source: Gartner, CATR, Nomura estimates

Two reasons behind the demand slowdown • 3G/4G transition triggered inventory correction We believe some smartphone vendors are clearing their old 3G smartphone inventory, which has slowed smartphone sell-in numbers. At the same time, some consumers may have delayed their smartphone purchases in anticipation of the new 4G smartphones to be launched in 2Q14 and onwards. We believe those are temporary issues and demand should gradually pick up in 2H14 when vendors are launching their CNY1,000 4G smartphone models. • VAT and other telecom regulatory changes may slow down operators’ sales activities We think operators may slow down their promotional activities temporarily in order to adjust their service plans and smartphone promotion strategies to adapt to the recent regulatory changes in the telecom sector, especially the value-added tax (VAT) reform (VAT reform finally arrives) and telecom tariff liberation (Implication from tariff liberalisation).

For example, in the VAT scheme, operators will have a tiered tax rate based on the type of service and product (6% for value added service tax, 11% for basic service, and 17% for product sales). A proper design of service/handset bundling contracts may help operators to lower their effective tax rate. In addition, operators may shift procurement away from some handset suppliers (mainly white-box) if they cannot provide VAT invoices. • Will operators cut handset subsidies? As part of the regulatory adjustment, we believe telcos are discussing the possibility of cutting their annual handset subsidy budget in order to create room to lower 4G tariffs. Telecom operators mainly provide handset subsidies in three segments, including flagship models (>CNY3,000, mainly by Apple and Samsung), CNY1000 models (mainly by ZTE, Huawei, Lenovo, Coolpad, Xiaomi) and low-end models (tier-2 local brand and

Nomura | China smart devices 21 May 2014 white-box makers). Depending on the segment in which they cut the subsidy, the step will affect the demand in that segment negatively.

Fig. 23: Nomura forecasts

China Smartphone Market Forecast 2011 2012 2013 2014F 2015F 2014 (CNY bn) A A A NOM NOM Company Total Smartphones (CATR based) 95 253 422 469 550 y-y 168% 67% 11% 17% % of total handsets 23% 55% 73% 75% 81% Sum of Three operators 95 220 360 410 450 488 China Mobile 30 60 155 180 200 200 China Telecom 15 60 75 75 80 100 China Unicom 50 100 130 155 170 188 Non-operator (0) 33 62 59 100 4G Smartphones 120 200 220 % of total smartphones 26% 36% China Mobile 80 120 100 China Telecom 10 20 70 China Unicom 30 60 50 Total Smartphones (Gartner based) 78 178 331 367 431 y-y 129% 86% 11% 17%

Source: CATR, Gartner, Company data, Nomura estimates

Our view on China’s smartphone market • 11% y-y volume growth in 2014F despite 9% decline in 1Q14 We think the slowdown due to 3G/4G migration and telecom regulatory adjustments are both temporary issues. We still expect China’s smartphone market to grow 11% y-y in 2014F despite a 9% decline in 1Q14. We expect demand growth to turn positive from 3Q14, driven by the ramp-up of affordable CNY1,000 4G smartphone models. • 4G smartphones to reach 120mn units vs. 220mn units targeted We expect China's 4G smartphone shipment volume to reach 120mn units in 2014 (vs. a total volume of 220mn units targeted by the three operators). As of 1Q14, 4G smartphone volume was only 9.7mn units, according to CATR data. In our forecast, we assume the regulator will issue FD-LTE trial licenses to China Telecom and China Unicom within 2014. If FD-LTE licenses are not issued, then the 4G smartphone shipment volume target may need to be revised down by 10-20mn units.

Fig. 24: Smartphone market shares in China

RankCompany4Q121Q132Q133Q134Q13 1 Samsung 15.9% 17.7% 18.6% 17.7% 17.3% 2 Lenovo 13.6% 10.2% 12.9% 13.1% 12.3% 3 Huawei 9.4% 10.1% 8.2% 8.2% 10.0% 4 Yulong 10.0% 9.8% 9.4% 9.0% 9.2% 5 Apple 8.7% 9.7% 7.3% 6.4% 7.9% 6Xiaomi1.5%2.6%3.0%4.0%6.2% 7 ZTE 8.2% 7.4% 7.8% 5.7% 3.8% 8 BBK 2.1% 2.4% 2.6% 4.4% 3.7% 9OPPO2.4%2.8%3.3%3.5%3.4% 10 Tianyu 4.1% 4.3% 4.6% 4.4% 2.9% Others 24.1% 23.1% 22.4% 23.5% 23.2%

Source: Gartner

• Industry consolidation likely to accelerate As shown below China’s smartphone market is still highly fragmented. The top-10 China brands had 57% market share as of 4Q13. The rest of the China brands had ~13% market share. We expect the market to further consolidate in the coming quarters, driven

Nomura | China smart devices 21 May 2014 by 4G migration (higher technology barriers) and VAT reform (telco order allocation shifting to larger players who can issue VAT invoices). • Moderate long-term growth due to high penetration rate China smartphone vendors’ growth in the past two years has been driven by: 1) rising proportion of smartphones in their total handset product mix, 2) market share gains from international handset vendors (mainly Nokia/Motorola), and 3) the growth of mobile subscribers in China. Smartphone shipment penetration reached 84% of China handset sales in 4Q13, according to Gartner, and 88% of 1Q14 handset sales according to CATR. At the same time, domestic smartphone vendors’ market share reached 70% of total volume, according to Gartner. This means that China smartphone vendors’ sales growth in China is likely to increasingly track total handset sales growth and, thus, slow down from previous growth rates. Based on our estimates, user penetration of smartphones still has scope for further growth, not least as users transition from 2G to 3G/3G smartphones. We expect this to ensure healthy (albeit slower) growth for smartphone sales in China going forward.

Fig. 25: High penetration rates limit long-term growth Fig. 26: User penetration still has room to grow Smartphone penetration rate within total handset shipments China smartphone users and 3G subscriber penetration rates Penetration rate (Gartner) Smartphone user penetration 100% 70% Penetration rate (CATR) 3G user penetration 60% 80% 50%

60% 40%

30% 40% 20%

10% 20% 0% 0%

1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14F

Source: Gartner Source: CATR, MIIT, Nomura estimates

China smartphone brands focus on exports and 4G Despite the slowdown in China’s market demand in 1Q14, most Chinese smartphone vendors remain bullish on their 2014 shipment targets, as summarized below.

Fig. 27: China OEM shipment targets

Sony(2013) LGE(2013) HTC(2013) 2013 Shipments TCL 2014 Target/Forecast Xiaomi Coolpad ZTE Huawei Lenovo

0 20406080100 (mn units)

Source: Company guidance, Nomura estimates

Nomura | China smart devices 21 May 2014

We do not expect all domestic vendors can achieve their targets simultaneously. We expect the growth will mainly come from smartphone exports and non-operator channel sales in China. On the export side, Huawei has built a solid market share in major export markets except for the US (7% in EMEA, 4.5% in Latin America, and 7.5% in APAC). ZTE mainly focuses on the US (5%) and Latin American (12.8%) markets. Thanks to its strong channel inherited from Alcatel, TCL’s market shares in Europe/MEA/Latin America are 2.7%/6.4%/8.4% respectively. If Lenovo can successfully close the deal to acquire Motorola, it will immediately emerge as the No.5 player in Latin America with also meaningful market shares in Europe and US (1.1%/2.8%), from a negligible pre- acquisition position in overseas markets. In the China market, we have noticed that Huawei and Xiaomi are very aggressive in increasing their market presence in the open channel. For example, we found quite a few local retailers promoting Huawei and Xiaomi brand smartphones together with Samsung and Apple, as in the photo below taken during our recent visit to Shenzhen’s consumer electronic shopping district, Huaqiangbei (华强北).

Fig. 28: ZTE/Huawei/TCL/Lenovo+Moto’s global market share Fig. 29: Huawei/Xiaomi are the two domestic brands by region alongside the likes of Samsung/Apple

14% Huawei ZTE Lenovo+Moto TCL

12%

10%

0% APAC EuropeMEA LA NA

Source: Nomura research

Summary of major domestic OEMs’ smartphone strategies • Lenovo (992 HK, Buy) Lenovo’s smartphone business has ramped up quickly over the past two years thanks to the co-operation with chipset suppliers like MediaTek and its well-recognized brand and sales network in China. Lenovo’s market share in China peaked in 2Q13 at 14.6%; since then it has declined gradually to 10.2% in 4Q13 due to the competition with other domestic OEMs. Looking into 2014, we expect Lenovo’s China smartphone business to reaccelerate in 2H14, driven by the ramp-up of new 4G models. For the overseas market, Lenovo is currently focusing on emerging markets in Asia and Russia in order to leverage its PC brand and sales channels in those markets. Meanwhile, we expect Lenovo to prepare for the acquisition of Motorola Mobility from Google priced at USD2.9bn in order to penetrate mature markets. After the close of this deal, we expect Lenovo to use the Motorola brand in mature markets and dual brands in emerging markets including China. We expect Lenovo (excluding Motorola) to ship 75mn

Nomura | China smart devices 21 May 2014 smartphones in 2014 (from 44mn units in 2013) driven by growth in both China and overseas markets. • Huawei (unlisted) Huawei targets to ship 80mn smartphones in 2014F, vs. 52mn in 2013. Since Huawei’s market share in China has stabilized at ~10% throughout 2013, we think a large portion of the growth will come from market share gains in overseas markets like Europe, Asia and Africa. We expect Huawei to focus on the mid-to-high end (>450USD) smartphone segment in 2014 in order to drive its profit growth along with volume growth. One good example is its recent flagship model P7 launched on 7 May, priced at USD629, in direct competition with other flagship models from major brands such as Samsung and Apple. On the other hand, we expect Huawei to focus on 4G/LTE smartphone development in order to leverage its strong ties with telecom operators, its expertise in telecom equipment and chipsets (Hisilicon). • ZTE (763 HK, Buy) We expect ZTE to ship 60mn smartphones in 2014, including 24mn LTE smartphones, from 40mn units in 2013. In China, ZTE saw market share losses during 2013 due to unpopular models and intensifying competition from other local brands. Its domestic market share peaked in 2Q12 (8.7%) and it lost market share to 3.8% in 4Q13. ZTE reshuffled its handset division management at the end of 2013 in order to regain market share in 2014. On the other hand, ZTE’s overseas expansion is quite successful. For example, in 4Q13, ZTE had 12.8% market share in Latin America and 5% in the US, according to Gartner. The company believes that the LTE smartphone transition marks a good opportunity to expand and increase market share globally. ZTE targets to expand its market share in those markets by improving relations with telecom operators and branding via marketing practices such as becoming the official smartphone sponsor of the Houston Rockets and the NBA. • Xiaomi (unlisted) We expect Xiaomi to ship 40mn smartphones in 2014, vs. 18mn in 2013. Unlike its larger peers in China, Xiaomi’s market share had been steadily increasing, from 1.5% in 4Q12 to a new high of 6.2% in 4Q13. In order to meet the target 122% y-y growth, Xiaomi has recently abandoned its “hunger marketing” strategy by accepting pre-orders for Hongmi (guaranteeing delivery within 37 days) and direct orders for MI3. Xiaomi plans to launch products in 10 emerging overseas markets in 2014, focusing on 10 countries in Southeast Asia and Latin America, where smartphone penetration is still low and e-commerce infrastructure is fairly developed. The company has recently registered mi.com to carry out its e-commerce distribution model internationally. • Coolpad (2369 HK, Neutral) Coolpad targets to ship 60mn units in 2014, from 40mn units in 2013, including 36mn LTE smartphones. As one of the top three domestic OEMs in China (behind Lenovo and Huawei), Coolpad also faces the 10% market share ceiling in China. In the domestic market, the company believes that LTE smartphone transition may be a game changer in the industry and will be pursuing an aggressive pricing strategy in launching LTE smartphones to drive volume. At the same time, the company aims to roll out cloud- based services such as storage, app stores, and other services to generate service revenue from its large smartphone user base. In the overseas markets, Coolpad plans to enter some emerging markets first, minimizing the risk of IPR lawsuits, since the company lacks a comprehensive IPR portfolio. • TCL Communication (2342 HK, Neutral) We expect TCLC to ship 35mn units in 2014F, from 18mn units in 2013. Its global smartphone market share has increased from 1% in 4Q12 to 2.6% in 4Q13. As the

Nomura | China smart devices 21 May 2014 leader among China OEMs in overseas markets, TCLC will continue leveraging its “Alcatel” brand to further increase its market share in key markets such as EMEA and Latin America. A key growth driver in 2014 is the US market; TCLC has contracted with major telcos to launch its products. On the other hand, its presence in China is rather negligible compared to its peers. The company believes that 4G migration presents a good opportunity to shake up the competitive landscape and plans to launch 20+ LTE products in 2014 to capture market share.

Smart Homes: a bigger market than smartphones? We noticed a boom to launch Smart Home strategies and products from the beginning of 2014 (summarized below). We see larger potential for product innovation in home appliances, as happened in the smartphone upgrade cycle in the past 2-3 years.

Fig. 30: Summary of major home appliance vendors’ Smart Home strategies

Smart Home Strategy Target Haier U‐Home 10mn U+ Smart Home users by 2015 1+1+1 strategy (1 smart home OS + 1 M‐Smart Interactive Community + Midea Sales contribution to reach 30% in 2016 1 M‐Box Management centre) TCL Double plus Become the top 3 vendor in Smart TV and Smartphone globally Skyworth 10mn smart TV users in FY2014/15 Gree Smart home solutions for its AC and air purifier products Hisense 1+1+N Strategy Source: Company data, Nomura research

Fig. 31: Home appliances have much smaller annual Fig. 32: But similar installed base shipments

(CNYbn) Sales (LHS) (mn units) (CNYbn) Ownership (LHS) 250 Shipments (RHS) 500 Penetration (RHS) 1,200 140% 200 400 1,000 120% 100% 150 300 800 80% 600 100 200 60% 400 40% 50 100 200 20% 0 0 0 0% TVs ACs PCs TVs ACs PCs Washing Washing Machines Washing Washing Machines Refrigerators Smartphones Refrigerators Smartphones

Source: AVC, Gartner, IDC, Nomura estimates Source: AVC, Gartner, IDC, Nomura estimates

Nomura | China smart devices 21 May 2014

Fig. 33: Major smart home appliance categories

Smart Product Features Haier Gree Midea Skyworth TCL Xiaomi TV Interactive TV with IPTV, apps, Internet connection, and other services x x x x Oven Programmable recipe download, ingredient delivery, and social network x x Refrigerator Monitors food refreshness and inventory xx x Cordless home Cordless connectivity to electricity x appliances Air purifier Monitors air quality and controls other appliances (eg. AC) x x x WiFi Central network connection hub for home appliances x x x x x Air conditioner Remote control, smart learning, and energy efficient x x x Water heater Smart learning and energy efficient x x Washing Remote control, energy efficient, and multi‐function (eg. Ultraviolet germ x Machine termination) Smartphone Device to remotely monitor and control home appliances x x x Game Console Central hub for home entertainment x Source: Nomura research

Fig. 34: Comparison of product mix for major home appliance makers (2013)

Gree

Skyworth

TVs

HiSense Refrigerators Air Conditioners

Washing TCL Machines Small Appliances

Others

Midea

Haier

0% 20% 40% 60% 80% 100%

Source: Company data, Nomura estimates

Haier’s U-Home strategy Haier’s U-Home strategy was first launched in 2006 with a vision to ultimately transform the company from providing products to providing services. Now it has taken the shape of a M2M solution to create a networked home environment. It enables users the ability to monitor and control home appliances from anywhere and at anytime. We have seen the widest range of smart home appliances, including ACs, ovens, TVs, cordless gadgets (eg, rice cookers, water heaters, etc), refrigerators, and air purifiers, among Haier’s domestic peers. TCL’s focus on TV games On 9 April, TCL revealed details about its “double plus” smart home strategy in its 2014 Spring Product Show. TCL also targets to increase the service related revenue contribution to 50% in five years from nearly zero in 2013. As the first step of TCL’s Smart Home strategy, TCL launched a new Android-based TV game platform by partnering with China Unicom (operator), JD.com (e-commerce), ATET (game platform solution) and Gameloft (game developer and publisher). TCL believe the new platform will greatly lower the incremental cost to develop games for multiple platforms (eg, smartphones, TVs, PCs). TCL has launched four console games with Gameloft in April 2014, and plans to launch at least one title per month in the future.

Nomura | China smart devices 21 May 2014

Fig. 35: TCL’s game console content partners

Source: TCL

Gree thinks Smart Home is too early On March 7, Gree hosted an investors’ forum to discuss its Smart Home strategy. • Gree’s focus is to provide air conditioner remote monitoring service Gree has integrated a communication module into its latest air conditioner models, and is partnering with telecom operators to remotely monitor the performance of those air conditioners in China. By applying data analysis based on actual operating data, Gree can identify potential problems in ACs and notify users with service suggestions before the unit actually falls into abnormal operation. In addition, Gree can also present investment payback analysis to users, recommending that they replace their energy- inefficient ACs with efficient ones. • Smart Home-based value-added services may not come any time soon Meanwhile, Gree noticed rising interest from the capital markets regarding Smart Home value-added services, especially after Google’s USD3.2bn acquisition of Nest and Haier’s recent new product launch such as Haier’s Cloud Oven. However, Gree thinks it is still too early to overly emphasize Smart Home concepts since: 1) the eco-system and consumer behaviour are not yet ready for Smart Home value-add services and 2) the lack of a common communications and control standard make machine-to-machine (M2M) communications difficult, especially cross-brand products.

Midea targets 30% Smart revenues by 2016 On March 10, Midea’s (000333 CH, NR) hosted a Smart Home strategy conference. During the meeting, Midea announced it was targeting 30% sales from Smart Home appliances by 2016, based on its “1+1+1” strategy, including: (1) its M-Smart hardware platform, which includes a set of WiFi and wireless communication modules as well as logic modules; (2) its M-community social network; and (3) its M-box home gateway. Midea has already launched smart air conditioners and smart kitchens (two of its largest product lines in March 2014, and it plans to launch more than 25 categories of Smart Home appliances in 2014 as well as cover all 30 major categories of white home appliances in 2015). • What does Smart Homes mean to Midea? Midea believes Smart Homes will eventually develop into an ecosystem in which traditional home appliances equipped with WiFi or RF communication modules will play an important role. It includes four different stages of development: 1) single home appliances with Internet connection and remote control functions, 2) multiple home appliances in a home connected and coordinated by a smart box (eg, M-Box in Midea, Nest in Google), 3) home appliances that interact with neighbourhoods, stores and hospitals, and finally 4) Smart Home ecosystems including both appliances and cloud- based services.

Nomura | China smart devices 21 May 2014

Fig. 36: Smart home products as a percentage of total sales Fig. 37: M-smart strategy: smart management system + M- community + M-box Smart home Traditional products 100%

80%

60%

40%

50% 20% 30% 5% 15% 0% FY14F FY15F FY16F FY18F

Source: Midea, Nomura research Source: Midea, Nomura research

Major Smart Home Products in China We think Smart Home products are still in their infancy stage in China and most vendors are still exploring various business models in an attempt to get customers to buy in for the premiums. Haier demonstrated a few interesting business cases during our visit. • Haier's cloud oven It is connected to a “smart-life platform”, where users can interact with professionals including chefs, dieticians, ingredient providers, etc. For example, a user may download a popular recipe from a dietician, have the required ingredients prepared and delivered, and consult a chef in the process of preparing the meal. In the end, the user can take pictures and share thoughts on the platform for others to see. • Haier Air Box Haier Air Box is a gadget that turns normal AC and air purifiers into smart appliances, and realizes intelligent control via its application and WeChat. It monitors indoor temperatures, humidity, PM2.5, and smoke, and carries out the appropriate actions through other home appliances controlled by it to maintain a desirable environment at home.

Fig. 38: Haier Air Box Fig. 39: Haier's cordless rice cooker

Source: Nomura research

Nomura | China smart devices 21 May 2014

• TCL T2 game console TCL announced that it intends to build a new Android-based TV game platform by partnering with China Unicom (operator), JD.com (e-commerce), ATET (game platform solution) and Gameloft (game developer and publisher). TCL launched an Android-based game console T2, and plan to integrate this game platform into TCL’s new TV models (TCL sold 9.9mn TVs in China in 2013). TCL Multimedia’s CEO, Mr. Hao Yi, stated that the new platform would greatly lower the incremental cost to develop games for multiple platforms (eg, smartphones, TVs, PCs). TCL has launched four console games with Gameloft in April 2014, and plans to launch at least one title per month in the future. In addition, TCL plans to launch 10 casual board games by June and 10 educational games by September 2014. • TCL’s 360 T3 Smart Air purifier Users can remote control air purifiers using phone apps, from which information and air monitoring data can be transferred to the 360 cloud platform. The 360 cloud platform provides indoor and outdoor air quality information for reference. In addition, the T3 Air Guard is also equipped with a new integrated filter and provides users with a convenient filter replacement service.

Fig. 40: TCL’s T2 game console Fig. 41: TCL’s 360 T3 Smart Air Purifier

Source: Nomura research

• Xiaomi’s home gateway – Mi Wifi Xiaomi’s Mi Wifi is an open source wireless router with expandable slots for additional storage; in addition, it provides a Software Development Kit (SDK) for developers to create customizable services and functions to be shared among users. Ultimately, Mi Wifi may become the connectivity hub of terminals and devices in homes. • Gree – smart air conditioners Gree’s smart air conditioner is not only connectivity-enabled, it also has infra-red sensors and a camera to monitor everything that is going on in the home within its range.

Nomura | China smart devices 21 May 2014

Fig. 42: Haier’s Smart Window Fig. 43: Smart air conditioner The window can be set to "show" different outside views or simply become transparent

Source: it168.com

Source: Nomura research

• Midea – smart water heater Midea’s smart water heater can be controlled remotely; in addition, it has built-in intelligence to carry out more functions automatically such as adjusting the water temperature based on surrounding room temperature for the best user experience. • Midea’s Smart kitchen system Smart refrigerators could realise better food management. For instance, they would not only identify foods but also track the shelf life of the food. When users download a recipe from M-Community, smart refrigerators would be able to automatically calculate whether there were sufficient raw materials available for this recipe.

Nomura | China smart devices 21 May 2014

Smart TVs: service market starts to take off TV hardware business still seeing challenging times According to AVC (All View Consulting), China’s TV shipments in 1Q14 declined by 10.5% y-y to 10.9mn units and sales declined by 13.3% y-y to CNY36.6bn, due to 1) weakness in the property market, 2) panel price declines, and 3) a lower proportion of high-end products (12% UHD in 2014 vs. 25% Smart TVs in 2013). We expect the decline to continue till May, but to be followed by a rapid growth recovery starting in June (the energy subsidy expired in May 2013) and throughout 2H14. The major challenges for domestic TV vendors in 2014 include: • ASP decline due to shift of sales to online channels We note the rising mix of online TV sales (~7% in 2014 vs. ~0% in 2013) in 1Q14, which we believe is negative for TV ASPs since TVs with similar specs typically sell 15~20% cheaper in online channels due to a lower channel mark-up, based on our study. • How to accelerate UHD upgrade Typically, TV vendors maintain or improve their blended ASPs by launching high-end models (4K2K TVs in 2014 and Smart TVs in 2013) and attracting consumers to buy larger-sized TVs. Drawing an example from Skyworth, the largest UHD TV vendor in China — from the 1Q14 results, we note that although the 4K2K TV penetration rate reached 12% vs. 0% in 2013, the ramp-up speed of 4K2K TV is slower than that of Smart TVs in 2013 (22% in March 2013 from 0% in March 2012). 2014 trends: larger display and UHD While we forecast 12% 4K2K penetration in 2014 (Skyworth has already achieved this penetration in 1Q14), AVC provides an even more bullish forecast of 17% penetration, or ~8mn units. Chinese consumers have ample appetite for large-sized TVs. DisplaySearch shows that the increase in TV panel size in China has historically surpassed that of the rest of the world, and the gap became wider in 2013. The pace of TV panel size increases has picked up in 2013, driven by the rising adoption of smart TVs. We believe consumer demand for more versatile smart TVs and 4K2K TVs will continue to fuel the demand for larger panels (40-inch+). We expect the demand for large displays to continue in 2014 for China TVs, outpacing the worldwide increase. AVC forecasts the average panel size will increase by 8% y-y to 42.8 inches. Shipments of 40-inch and above TVs in China reached a historical high of 49% in 1Q14, from 38% in 2013, partly driven by accelerated smart TV and UHD TV adoption.

Fig. 44: China TV shipment trends and growth rates Fig. 45: China TV ASP and panel size trends

('000 units) China TV Shipments (LHS) (CNY) ASP (LHS) (inch) 5,000 y-y growth (RHS) 16% 4,000 Panel Size (RHS) 44 3,918 42.8 3,900 42 4,800 12% 3,800 40.3 4,600 40 3,730 8% 3,700 4,400 38 3,600 37.3 4% 3,576 4,200 36 3,500 35.7 0% 3,479 3,456 34.3 34 4,000 3,400 -4% 3,800 3,300 32

3,600 -8% 3,200 30 2010 2011 2012 2013 2014F 2010 2011 2012 2013 2014F

Source: AVC Source: AVC

Nomura | China smart devices 21 May 2014

Fig. 46: China TV shipment breakdown by panel size Fig. 47: TV display size trends: China vs. World

<29'' 32-39'' 40-48'' >50'' (inch) China World 42 100% 3% 4% 5% 4% 5% 7% 9% 10%10%13% 40.1 90% 16%16%17% 39.7 39.8 40 80% 29% 38.6 35%39%39% 31%29% 28% 41% 30% 29% 37.7 70% 31%30% 38 37.3 32% 36.6 36.8 36.1 60% 35.7 35.9 37.937.8 36 35.1 37.1 37.037.2 50% 36.6 46% 33.8 35.9 36.1 40% 42% 48% 35.6 41% 52% 34 35.1 35.1 43%43% 54%56%52% 30% 50%50%46% 34.3 20% 32 33.2 10% 21%19%16% 13%11%15% 9% 0% 6% 6% 5% 4% 4% 4% 30 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14

Source: DisplaySearch Source: DisplaySearch

Smart TV service shows sign of growth Based on Skyworth data, its Smart TV penetration reached 37% in 2013, from 15% in 2012. The buzz created by LeTV’s Super TV fuelled public perception and demand for smart TVs in China. We expect smart TV penetration to reach 45% in 2014F in the overall China TV market. We forecast Smart TV shipment volume will show a 36% CAGR between 2013F and 2015F, with the Smart TV penetration rate reaching 60% by 2015F, from 25% in 2013F. In addition, we expect the Smart TV user base will show a 38% CAGR, with the penetration rate over total TV users reaching 24% by 2015, from 8% by 2013F. The rapid expansion in the IPTV user base will be critical for IPTV players to monetize non- hardware revenues such as data mining, advertising, paid subscriptions, apps, etc. The introduction of entry level 4K2K models is driving down 4K2K TV prices to as low as CNY2999 (~USD488), which typically feature a sub-50-inch panel and 60Hz refresh rate. Skyworth is currently the leader in 4K2K sales in China with ~40% market share. The company launched its entry level 4K2K TVs in 4Q13, which gave a boost to its 4K2K TV adoption rate, which reached 12% in 1Q14 (~210k units). In addition, competition from Internet companies is starting to bring down 50-inch and above 4K2K TV prices. For example, LeTV launched its X50 Air in April 2014, a 50-inch 4K2K TV priced only at CNY2999 (~USD488), excluding a two-year mandatory CNY980 subscription fee. It is about 50-70% of the price of a traditional 4K2K TV sold via retail channels with a similar panel size. We think it will exert pricing pressure on 50-inch and above 4K2K TVs, similar to what happened in the smart TV space in 2H13 when LeTV launched the low-priced S50 (50-inch) and S60 (60-inch) Super TVs. • Skyworth: its Coocaa brand launched a comprehensive product portfolio including 40/50-inch smart and 4K2K TVs with its latest Tianci 4.0 OS. Skyworth currently has 1.2mn DAU with 4.5 hours of average TV viewing time. The company targets to reach 10mn DAU by end of FY2014/15, a critical mass that can be potentially monetized in different ways, including advertising, e-commerce, content subscription, etc. • TCL: focuses on “smart home” O2O strategy (smart + internet and product + service). TCL targets to transform itself from a product centric to a service and customer centric company by developing more than 10-mn residential users and 100mn mobile users with service ARPU contribution, which the company targets to reach 50% in five years. In addition, its Android-based TV game platform T2 will be a differentiator from other home appliance vendors. • Hisense: Launched its Vidaa 2 smart TV on 1 May 2014, featuring upgrades based its previous Vidaa TV, including content integration service and a cross-platform (mobile, PC, and TV) social network. • LeTV: following the success of its Super TV series in 2H13, LeTV launched its first 4K2K TV (X50 Air) in April 2014, setting another pricing benchmark in the TV space.

Nomura | China smart devices 21 May 2014

Fig. 48: Comparison of 4K2K TVs [as of May 2014] 1) LeTV brings down price benchmark for 4K2K TVs and 2) entry level 4K2K TVs typically feature a lower refresh rate (60Hz) and sub-50-inch display Brand LeTV Skyworth Skyworth Skyworth Skyworth TCL Konka Model X50 Air Coocaa (40U1) Coocaa (58U1) 42E8EUS 58E8EUD D55A571U KKTV LED55K60U

Hardware Spec Screen Size (inch) 50 40 58 42 58 55 55 Resolution 4K2K 4K2K 4K2K 4K2K 4K2K 4K2K 4K2K Refresh Rate (Hz) 60 60 60 120 120 120 120 Processor Quad‐core Dual‐core Quad‐core Dual‐core Dual‐core Quad‐core Octa‐core Operating System LeTV UI Tianci Tianci Tianci Tianci MagicCube UI Android Features 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 2999 (3979 with Retail price (CNY) subscription) 2999 5999 3599 7999 5999 5699 Sales/Mar in USD 488 (647) 488 975 585 1301 975 927 keting Sales Channel e‐channel only e‐channel only e‐channel only e‐channel and retail e‐channel and retail e‐channel and retail e‐channel and retail strategy Logistics/ after Outsource In‐house In‐house In‐house In‐house In‐house/outsource In‐house/outsource service Content Provider CNTV, Proprietary SMC, Voole, others SMC, Voole, others SMC, Voole, others SMC, Voole, others Wasu/iQiyi BesTV Industry License CNTV SMC SMC SMC SMC Wasu BesTV Partner TV OEM Hon Hai/TPV Skyworth Skyworth Skyworth Skyworth TCL Konka Panel Sharp (DSP) LGD/AUO LGD/AUO LGD/AUO LGD/AUO CSOT/Samsung LGD/AUO

Source: Nomura research

Nomura | China smart devices 21 May 2014

Information security and IT nationalism We see a clear trend to promote the adoption of domestic equipment and components since mid-2013 after media reports about the US surveillance program PRISM. In November 2013, China established the National Security Committee (NSC, 国家安全委员会) which is chaired by China President Mr. Xi Jinping. NSC’s mission includes: • Strengthen regulatory oversight of the internet (加大依法管理网络力度), • Accelerate the institutional establishment of an internet management system (加快完善互联网管理领导体制), • Secure the safety of national networks and information (确保国家网络和信息安全). As shown in the figure below, Semiconductor and network equipment are two areas which are critical to the whole IT infrastructure, but Chinese vendors still lag behind in terms of market share.

Fig. 49: Chinese vendors’ global market share (2013)

Handset Huawei, ZTE, Lenovo, Coolpad, etc... Router Huawei, ZTE Storage Huawei Server (x86) Lenovo+IBM, Huawei, Inspur, Sugon

Semicoductor (Logic and Memory) SPRD, SMIC, HiSilicon Display CSOT, BOE Touch Panel Truly, O-Film Camera Sunny Optical, Truly, O-Film Casing/Mechanical BYDE, Tongda Acoustic AAC, Goertek Battery BYD, ATL, Lishen

0% 20% 40% 60% 80%

Note: market share data based interviews with Chinese firms and Nomura China Technology estimates Source: Nomura research

Semiconductor: government may launch IC fund • CNY30bn industry fund to support domestic vendors On top of the current “Policies to further promote software and IC industry development: 进一步鼓励软件产业和集成电路产业发展的若干政策, AKA new document 18, released by State council in January 2011, the market expects the Chinese government to launch a CNY30bn industry fund to support the development of China’s IC sector in four areas: 1) enhance IC design, manufacturing, packaging, testing, and equipment; 2) set up labs and R&D centres; 3) promote industry consolidation to establish several world-class competitive IC companies; and 4) develop IC industrial parks. • Anti-trust investigation against foreign IC vendors In addition, the recent anti-trust investigation against Qualcomm (QCOM US, Buy) by the National Development and Reform Commission (NDRC) also reflected rising concerns within the Chinese government regarding the dependency of China’s IT industry on US IT firms. • Limited investment targets: SMIC and Fudan Microelectronics After the privatization of Spreadtrum and RDA, there are limited investment targets listed in the offshore market currently. On the foundry side, SMIC (981 HK, Neutral) may benefit in potential foundry industry consolidation to further increase scale. On the fabless IC design side, Fudan Microelectronics may benefit from rising demand for finance IC cards. (Please refer to the chart in appendix for a complete list of IC players in China)

Nomura | China smart devices 21 May 2014

Network equipment: Lenovo/Huawei to benefit Unlike in telecom equipment, Chinese vendors’ global market share in network equipment remains trivial, even in China. Chinese vendors only own 21% market share in x86 servers and 10% in storage, according to Gartner. In high-end products such as Power PC (RISC) servers, we see Chinese vendors continuing to lag behind in technology terms. Since the disclosure of PRISM, we believe Chinese government have started to promote the replacement of IOE (IBM, Oracle, EMC) or IOC (IBM, Oracle and Cisco) equipment using domestic equipment. In our view, Huawei is currently the largest beneficiary because of its comprehensive IT hardware product portfolio. We also note Lenovo is quickly improving its position in the server/storage market via its recent acquisition of IBM’s x86 business and JV with EMC. If Lenovo can successfully complete the acquisition of IBM’s x86 server business, the major benefit for Lenovo should be significant market share gains in China’s server market.

Fig. 50: Enterprise revenues of major China vendors (2013)

(CNYbn) Enterprise sales (LHS) Total sales exposure (RHS) 18 84% 90%

15 75%

12 60%

9 45%

6 30%

3 6% 15% 3% 5% 0 0% Lenovo Huawei Inspur ZTE

Source: Company data, Nomura estimates

• Network delivery: ChinaCache (CCIH US, NR) and 21Vianet (VNET US, NR) may benefit from rising data centre demand in China due to regulatory tightening to restrict foreign Internet Data Centres (IDCs) and Content Delivery Network (CDN) players in China. Summary of information security related players • Huawei (unlisted) Huawei’s enterprise network business (USD2.5bn in sales in FY13, +32.4% y-y) continues to show strong growth, driven by the China market and breakthroughs in high- value markets in EMEA. Huawei has a comprehensive enterprise product business covering servers, storage, routers, and IP security. Huawei targets the sales of enterprise business to reach USD10bn by 2018, driven by the improved sales via channel partners and technology innovation. • ZTE ZTE currently supplies low-end integrated service routers to Chinese telecom operators and Internet companies (Baidu/Alibaba/Tencent). Enterprise network business contributed ~5% of sales (~USD600mn sales) in 2013, but is growing rapidly. ZTE also has a complete product line for the enterprise IT market, ranging from network infrastructure, video conferencing to cloud computing terminals.

Nomura | China smart devices 21 May 2014

• Lenovo Lenovo doesn’t have router business. On the other hand, Lenovo’s servers and storage business contributes 2% of its FY12 sales, and is showing strong future prospects, although it is a marginal player among its international peers. The acquisition of IBM’s x86 business will immediately turn Lenovo into a major player globally with 13.8% market share and a dominant player in China with 36% market share. Lenovo + IBM may be able to further expand its dominant share by eyeing Dell/HP’s 34% market share, fully taking advantage of the IT equipment nationalism sentiment in the country. Globally, we expect the deal to help raise Lenovo’s global x86 market share to 15% in 2014 and boost Lenovo’s overall revenue by 15%. • Digital China In enterprise business, Digital China (DC) mainly distributes imported equipment and software from US companies, including servers, storage, routers, and network security products. In 2013/3, DC’s sales here totalled HKD26bn (USD3bn), representing 35% of the company’s sales and 56% of its EBIT. Unlike Huawei, ZTE, and Lenovo, we expect Digital China’s enterprise IT business to face a structural slowdown due to concerns on national security issues in China with regard to US equipment. We expect DC to ramp up its sales for Huawei/ZTE/Lenovo products in the future to avoid the risk of relying on foreign products.

Fig. 51: Global x86 server market share (2013) Fig. 52: China x86 server market share (2013)

Others, 5% Oracle, 2% Others, 27.9% Sugon, 6% HP, 32.1% Lenovo + Inspur, 7% IBM, 36%

Huawei, 10%

Cisco, 6.3%

HP, 16% Leveno + Dell, 19.9% IBM, 13.8% Dell, 18%

Source: Gartner Source: Gartner

Fig. 53: Global storage market share (2013) Fig. 54: China storage market share (2013)

Others, Others, 18% 22% EMC, 23% EMC, 25%

Hitachi, 7% NetApp, 5%

Dell, 5% NetApp, HP, 15% 11% Hitachi, 7% IBM, 19%

IBM, 12% HP, 7% Dell, 14% Huawei, 10%

Source: Gartner Source: Gartner

Nomura | China smart devices 21 May 2014

Fig. 55: Global router market share (2012) Fig. 56: Global network security market share (2012)

Brocade, Others, 5% Juniper 3% Others, 25% Cisco, 23% Networks, 5% WatchGuard Technologies, HP, 7% 2% Dell Huawei, (SonicWALL), Check Point 10% 2% Software IBM, 3% Technologies, HP, 3% 17% Cisco, 70% Palo Alto Networks, 4% Juniper Networks, McAfee 10% (Intel), 5% Fortinet, 6%

Source: Gartner Source: Gartner

Nomura | China smart devices 21 May 2014

Electric Vehicle: How do you have a beautiful China without some green cars? Promoting electric vehicles to control air pollution As part of its air pollution control programme, China’s central government has an EV subsidy program as summarized in the figure below in order to promote the adoption of electric vehicles in China. Details of EV subsidy programme According to the programme, the central government will provide up to a CNY60k/unit subsidy for pure electric vehicles, up to CNY35k/unit for plug-in hybrid electric vehicles (PHEVs) and up to CNY500k/unit for electric buses. The central government’s subsidy for electric passenger vehicles will decline by 5%/10% in 2014/2015 vs. 2013. • MoF will continue the EV subsidy programme after the expiration of the current policy in 2015. Details of the new policy will be announced in due course. • MoF emphasized that participant cities are restricted from setting hurdles to limit the sales of non-local brand EVs, and specifically pointed out local EV standards and local qualified EV lists as ways of local protectionism.

Fig. 57: Summary of electric vehicle subsidy programme in 2013

Condition for central Subsidy government subsidy (kCNY/car) 80 ~ 150 35 Pure electric Minimum EV Range (km) 150 ~ 250 50 Electric > 250 60 Passenger Plug‐in Vehicle Minimum EV Range (km) 50 35 Hybrid Hybrid no subsidy 6~8 300 Pure electric Length of bus (meter) 8~10 400 Electric Bus >10 500 Hybird no subsidy Note: Subsidy for non-bus EVs will decline by 5% in 2014 vs. 2013 and 10% in 2015 vs. 2013 Source: MoF

Fig. 58: List of participant cities in the central government EV subsidy programme

City name Total (units) City Total (units) Beijing 北京 35,020 Zibo 淄博 5,000 Shenzhen 深圳 35,000 Luzhou 泸州 5,000 Tianjin 天津 12,000 Xiangyang 襄阳 5,000 Xi‘an 西安 11,000 Taiyuan 太原 5,000 Wuhan 武汉 10,500 Jincheng 晋城 5,000 Shanghai 上海 10,000 Ningbo 宁波 5,000 Guangzhou 广州 10,000 Zhangzhutan 长株潭 5,000 Chongqing 重庆 10,000 Haikou 海口 5,000 Changchun 长春 10,000 Chengdu 成都 5,000 Linyi 临沂 5,690 Kunming 昆明 5,000 Zhengzhou 郑州 5,500 Lanzhou 兰州 5,000 Weifang 潍坊 5,500 Hebei 河北省城市群 13,141 Qingdao 青岛 5,200 Zhejiang 浙江省城市群 10,100 Guanhu 莞湖 5,100 Fujian 福建省城市群 10,000 Liaocheng 聊城 5,010 Jiangxi 江西省城市群 5,000 Dalian 大连 5,000 Guangdong 广东省城市群 10,000 Hefei 合肥 5,000 Inner Mongolia 内蒙古自治区城 5,000 Xinxiang 新乡 5,000 Jiangsu 江苏省城市群 18,085 Shenyang 沈阳 5,000 Guizhou 贵州省城市群 5,000 Ha'erbin 哈尔滨 5,000 Yunnan 云南省城市群 5,000 Total EV 336,846

Source: MoF, Nomura research

Nomura | China smart devices 21 May 2014

There are currently 40 cities/regions qualified for the central government’s EV subsidy programme, versus 25 in the previous programme. All participant cities have an EV target totaling ~330k units by the end of 2015. On top of detailed policies from the central government, 5 cities/regions have announced their local EV subsidy implementation plans. • Beijing EV shipment target of 35k units, including 5k e-buses, 10k each for e-taxis, consumers, and car-rental. The city will provide subsidies to qualified pure-EV, PHEV, and fuel-cell vehicles, matching that provided by the central government 1:1. For infrastructure, the government will provide 30% of the investment as a subsidy to new energy vehicle related infrastructure deployment projects. In addition, EV buyers may obtain EV licenses in a separate lottery pool, which significantly increases the success rate (70%+) compared to obtaining a license for a traditional gasoline vehicle (~10-15%). • Shenzhen EV shipment target of 35k units, including 5k e-buses, 10k each for e-taxis, consumers, and car-rental. The city will provide subsidies to qualified pure-EV, PHEV, and fuel-cell vehicles, matching that provided by the central government 1:1. EV buyers may receive licenses directly, compared to the possibility of a “limit purchase” policy to be implemented for gasoline vehicles in the future. • Guangzhou EV shipment target of 10k units, including 2k e-buses, 1k e-taxis, 2k government vehicles, 1k special purpose vehicles (sanitation, postal, and logistics), and 4k consumer vehicles. The city will provide subsidies to qualified pure-EV, PHEV, and fuel-cell vehicles, matching that provided by the central government 1:1. EV buyers may receive licenses directly, compared to the “limit purchase” policy implemented for gasoline vehicles. • Tianjin EV shipment target of 12k units, including 11.5k public purpose vehicles (buses, taxis, sanitation, government, postal, and logistics), and 0.5k consumer vehicles. The city will provide subsidies to qualified pure-EV, PHEV, and fuel-cell vehicles, matching that provided by the central government 1:1. EV buyers may receive licenses directly, compared to the “limit purchase” policy implemented for gasoline vehicles. • Jiangsu region EV shipment target of 5.3k units in 2014 and 15k units in 2015. The region will provide subsidies to qualified pure-EV, PHEV, and fuel-cell vehicles, matching that provided by the central government 1:1. EV buyers may receive licenses directly, compared to the “limit purchase” policy implemented for gasoline vehicles. Nomura view: China EV market to show 234% CAGR to reach CNY75.9bn in 2016F Instead of pure-EVs, we think PHEV (plug-in EV) will become the main driving force behind EV adoption in the consumer market; since PHEV provides the benefits of EV (fuel cost efficiency and being environmentally clean), it also mitigates common consumer concerns on EVs (eg, lack of charging infrastructure and inconvenient for long-distance travel). On the other hand, we think pure-EV adoption will mainly take place in the public transportation space as e-buses and e-taxis. The common concerns mentioned above are less impactful because buses always follow a planned route, and taxis almost always stay in the designated city.

Nomura | China smart devices 21 May 2014

We forecast EV shipment volume in China between 2014-16F to be ~330k units, including 50k e-buses, 70k pure-EVs, and 210k PHEVs. We expect China’s EV market to show a 234% CAGR from CNY5.9bn in 2013 to CNY75.9bn in 2016. We think the rapid growth in the EV market is a game-changer opportunity for domestic auto makers such as BYD to quickly catch up in both technology and market share terms versus its domestic and international peers. For example, BYD’s 1Q13 traditional auto market share in China is ~2.3% (according to CAAM), distantly trailing other cross-border JVs. However, its 1Q13 EV market share in China reached 30%, according to d1EV, benefiting from its technological and operational know-how in the EV space during China’s EV transition.

Fig. 59: China EV market forecasts

Electric Vehicle 2012 2013 2014E 2015E 2016E 2014-2016 Electric Vehicle Market (CNYbn) 6.2 5.9 26.8 49.5 75.9 Y-Y -5% 351% 85% 53% e-Bus 3.4 3.4 20.0 28.5 45.1 Pure-EV 2.9 2.5 4.5 5.7 9.5 Plug-in Hybrid EV - 0.0 2.3 15.3 21.3 Market Size (k units) 11,237 10,260 36,300 115,500 178,200 330,000 Y-Y 254% 218% 54% e-Bus 1,682 1,690 10,000 15,000 25,000 50,000 Pure-EV 9,555 8,379 15,000 20,000 35,000 70,000 Plug-in Hybrid EV - 191 11,300 80,500 118,200 210,000 Total Battery Demand GWh) 1.2 1.1 4.6 7.6 12.6 Y-Y -6% 317% 65% 65% e-Bus 0.61 0.61 3.60 5.40 9.00 Pure-EV 0.57 0.50 0.90 1.20 2.10 Plug-in Hybrid EV - 0.00 0.15 1.05 1.54

Source: d1EV, MoF, Nomura estimates

2014 BJ auto show: automakers are serious in developing an EV eco-system We noticed rising interest from both domestic and international auto makers in launching their electric vehicle models this year, which reflected the impact of the Chinese government’s regulatory support for accelerated EV adoption. • BYD/Denza launched three EV models this year BYD and Denza, its JV with Daimler, together launched three electric vehicle models: (1) Tang (唐): a plug-in hybrid electric SUV; (2) Denza, a B-class pure electric-vehicle jointly developed by Daimler; and (3) Qin’s pure EV version which supports an electric range of 200km. • BAIC (Beijing Auto) plans to launch a comprehensive portfolio of EVs In addition to BYD, we noticed that Beijing Auto (BAIC) is also aggressive in EV development. BAIC management stated that the company has sold 2,326 electric- vehicles in 2012 and 2013, which had accounted for 25% of China's electric passenger vehicle market at the time. BAIC launched its A0 class EV C30 and B class EV C70 in 2014, and plans to extend the electric-range of existing models. The company targets to launch new C-class, A-class, A00 class and cross-over type EVs in the coming years. In addition to BYD and BAIC, we also see more domestic auto makers launching EV models. The chart below is a list of EVs we saw during the Beijing Auto Show.

Nomura | China smart devices 21 May 2014

Fig. 60: 2014 Beijing Auto Show EV summary

Battery 0-100km/h Battery Top speed Charging Price before Category Company Name Type Mileage acceleration Size (kWh) (km/hr) time (hrs) Subsidy(CNY k) (km) (s) Plug-in EV BYD Qin Sedan 14 70 5.9 185 5 189 Plug-in EV BYD Tang SUV na 85 4.9 na na na Plug-in EV SAIC Roewe 550 Sedan 12 58 13.2 200 6 249 Plug-in EV Geely 帝豪Cross SUV na 50 10.0 190 na na pure-EV BAIC E150 Sedan 45 150 25.8 120 6 260 pure-EV BYD E6 MPV 60 300 8.0 140 4 300 pure-EV BYD/Daimler Denza Sedan 48 300 4.3 150 3 369 pure-EV Tesla Model S 85 Sedan 85 368 5.6 200 8 734 pure-EV SAIC Roewe 50 Mini Sedan 18 120 14.6 130 6 235 pure-EV JAC iEV Version 5 Mini Sedan 19 200 na 95 8 170 pure-EV Chery S15 Mini Sedan na 150 15.0 100 8 na pure-EV Zotye E20 Mini Sedan na na na 80 6 na

Source: Nomura research

Will there be enough battery production capacity to accompany the EV growth? If the EV demand really surges as expected, we believe it will create a serious shortage of EV batteries as well as key EV battery materials such as Anode, Cathode, electrolyte solution, separators, and lithium-ion and cobalt mine. (Please refer to the battery value chain chart in the appendix). According to China’s EV development plan, China targets total EV ownership to reach 500k units by 2015 and 5mn units by 2020. This will translate into 1mn units of EV shipments/year on avg from 2015 onwards. Based on those two targets, we expect China’s total EV battery demand to reach 12GWh in 2015F, and 40GWh in 2020F. To put it into proper perspective, this demand is 14% larger than Tesla’s recently announced Gigafactory, which has a planned production capacity of 35GWh. According to the Institute of Information Technology’s (IIT), global production capacity of lithium-ion battery factories likely reached 34GWh in 2013. Similar to Tesla’s battery strategy, BYD is also aggressively expanding battery capacity. According to Ms. Li Ke, BYD’s North America CEO, the company plans to bring its battery capacity from 1.6GWh in 2013 to 6.5GWh in 2014 and 15GWh in 2015, expanding almost 10x over a period of two years.

Fig. 61: China EV battery demand forecasts and BYD/Tesla battery capacity

Total e-Bus Pure-EV Plug-in Hybrid 45

40 35 35 10

25 12 20

15 2 10 18 1 4 5 2 1.6 4 6 - 2014 2015 2020 BYD (2013) Tesla (2020)

Note: Battery size assumption: e-bus (360kWh), pure-EV (60kWh), plug-in hybrid (13kWh) Source: Nomura estimates

Nomura | China smart devices 21 May 2014

Fig. 62: Comparison of worldwide Li-ion battery production capacity and Gigafactory

Source: Tesla

Nomura | China smart devices 21 May 2014

3D vision and smart drive We see many potential applications for 3D vision beyond handsets including game consoles, gesture control applications (eg, Leap Motion). Within lots of pilot projects, we think Google’s Project Tango and Amazon’s 3D smartphone are the most interesting projects. • Google Project Tango Project Tango is an Android-based smartphone with three camera modules and one dedicated vision processor. It can create a 3D map of an environment in real time, a function that has never been realized in smartphones, to our knowledge, due to limitations in processor power and battery life. • Amazon’s 3D smartphone According to DigitalSpy, Amazon plans to launch a 3D smartphone in 3Q14. This smartphone has four front-facing cameras that work with other sensors to facilitate the software’s 3D effects. The device’s extra cameras are used to track the position of the user’s face and eyes in relation to the phone’s display. This allows Amazon’s software to make constant adjustments to the positioning of on-screen elements, altering the perspective of visuals on the screen. Another smart use for the phone’s 3D effects is across Amazon’s various stores, such as its book store, music store and the main Amazon digital market. By shifting the position of the phone, users are able to see three- dimensional product images at different angles to reveal surfaces that cannot be seen in 2D photos.

Fig. 63: Illustration of Tango’s sensors

Source: Techbang.com

• Implications for handset value chain We believe rising adoption of 3D images will increase the dollar per unit in the smartphone, and benefit handset camera module suppliers like Sunny Optical and Truly. Below are other 3D vision-related projects we have identified. • Case 1: eBay’s 3D virtual clothes Ebay (EBAY US, Not rated) acquired PhiSix (unlisted) recently to let online shoppers virtually "try on" jeans, dresses, shirts, and other clothing to see how they fit and look in an online environment. http://news.cnet.com/8301-1023_3-57619164-93/ebay-acquires-phisix-which-lets-users- try-on-3d-clothes-virtually/ • Case 2: 3D indoor mapping for furniture shopping Google demonstrated a 3D indoor map application (http://youtu.be/9_GD7kUbogk), which can create a 3D map of your living room in real time via Project Tango. By using the geometry information generated from this application, users can try to virtually fit furniture into their rooms easily.

Nomura | China smart devices 21 May 2014

• Case 3: augmented reality games Augmented reality (AR) is a live, copied, view of a physical, real-world environment in which elements are augmented (or supplemented) by computer-generated sensory input such as sound, video, graphics or GPS data. • Case 4: user interface in mobile gaming Until now, 3D computer vision has mainly been used to recognize people’s movement, and has been implemented in game console devices. Commercial devices launched include Microsoft’s Kinect, Leap Motion (developed by Sunny Optical), and Intel’s RealVision, etc.

Fig. 64: Case 1 – 3D virtual clothes Fig. 65: Case 2 – 3D indoor mapping for furniture shopping The shopper scans herself to create a virtual model to try on different The virtual model of the room is created after scanning the real room with virtual clothes also scanned to determine the fit and look Project Tango. User may then fit in virtual furniture for decorative planning

Source: Slashgear.com

Source: Nomura research

Fig. 66: Case 3: Augmented reality game Fig. 67: Case 4: User interface in mobile gaming A gamer playing ghost hunting in an augmented reality game Leap Motion gesture control

Source: hanselman.com

Source: Inquisitr.com

Vehicles are now touch “Smart” In addition to portable devices, we also see rising interest in the application of cameras in smart drive vehicles, driven by the U.S. government’s regulatory changes to mandate rear cameras by 2018 to enhance vehicle safety. On 31 March 2014, the US National Highway Traffic Safety Administration (NHTSA) announced a new vehicle safety standard that mandates automakers to install back-up cameras in all vehicles sold in the US by 1 May 2018. According to NHTSA estimates, the new vehicle safety regulation may create USD43-45/vehicle additional costs for the camera and USD87~USD99/vehicle cost for the display panel and other components. NHTSA Announces Final Rule Requiring Rear Visibility Technology

Nomura | China smart devices 21 May 2014

The vehicle lens market in the US has similar potential as China’s smartphone lens market. Since September 2012, we have been highlighting vehicle lenses as Sunny’s long-term earnings driver and the introduction of rear camera regulations may accelerate its market growth. (Sunny Optical: Raise TP to HKD5.60, maintain BUY). Based on our current estimates, if the adoption rate of rear cameras in US/EU reaches 100%, the total market size of vehicle lens sets may reach 27mn units, or USD192mn, which is equivalent to 72% of the China smartphone lens set market. If we assume 40% GPM for lenses and 13% GPM for camera modules, the total addressable market for US/EU vehicle lens sets is equivalent to 45% of China’s smartphone camera modules (Sunny’s current core business).

Fig. 68: China smartphone lens vs. US/Europe vehicle backup camera lens volume and gross profit potential (2013)

(mn USD) (mn 300 units) 268 300 250 268

192 250 200 200 150 150 100 100

50 27 50

- - Chinese Lens US/Europe Auto Chinese US/Europe Auto Market Size Lens Market Size Smartphone OEM Volume Volume

Source: Nomura estimates

In addition to camera modules, we think the new regulation could also benefit vehicle LCD display makers such as Truly (732 HK, NR). According to Truly, the company is a major vehicle display vendor worldwide, with key clients including Continental, Delphi, and Nippon Seiki. Its vehicle-related business contributed 9% of revenue in 2013.

Fig. 69: Illustration of a vehicle backup camera

Source: Nomura research

Nomura | China smart devices 21 May 2014

Fig. 70: Vehicle backup camera phase-in schedule

Vehicle Manufacturing Date Backup camera adoption rate Before May 1 2016 0% May 1 2016 to May 1 2017 10% May 1 2017 to May 1 2018 40% After May 1 2018 100% Estimate adoption cost per vehicle (USD) Full system installation (display + camera) 132 - 142 Camera-only installation 43 - 45 Backup camera adoption in 2018, assuming the rule is not mandated Lowest-to-highest scenario 59% - 73%

Source: NHTSA, Nomura research

Automakers and their suppliers are actively working with internet companies to make vehicles “smarter”. We think it is a gradual process starting from enhancing external sensors, to introducing driver-system interaction in the cockpit, to partially freeing up drivers with intelligent driving assist functions, to ultimately freeing up drivers completely with intelligent auto drive. From a hardware perspective, we are observing several trends, including 1) more sensors inside and outside of a vehicle (eg, cameras, infra-red, motion detectors, etc); and 2) larger panels (eg, central displays are growing from ~5-inches to 7-inches+). From a software/service perspective, we are observing the development of interactive services (eg. OS, apps, and alternative controls including voice and gesture), by companies such as Tencent, Google, and Apple with auto makers; in addition, we are also observing cooperation between auto makers and 3rd companies (eg, insurance providers) to jointly introduce services based on big data.

Fig. 71: What is Auto Drive? Fig. 72: Intelligent auto drive

Source: Bing.com

Source: Delphi

Nomura | China smart devices 21 May 2014

Fig. 73: Sensor built in to enable gesture control of vehicle Fig. 74: HUD projection system to prevent driver distraction entertainment system

Source: Nomura research

Source: d1EV.com

Fig. 75: BMW’s driving assist system Road information can be projected and shown on the windshield; in this case, it is telling driver the distance to the next traffic light and the approximate time left for the light to change

Source: Nomura research

Nomura | China smart devices 21 May 2014

Links to our recent reports Telecom & Telecom Equipment China telecom services - Implication from tariff liberalisation China Telecom Service - VAT reform finally arrives China telecom sector - Will China form a new tower company? China technology - Huawei analyst summit takeaways China Mobile (941 HK, Neutral) - New 4G plan and handset subsidy cut China Mobile (941 HK, Neutral) - Paying the price of business transition China Unicom (762 HK, Buy) - 1Q14 review: continues to outperform China Unicom (762 HK, Buy) - Forecast updates; Buy China Telecom (728 HK, Neutral) - Maintain Neutral, TP cut to HKD3.5 China telecom services - 2014F: The beginning of the TD-LTE era ZTE Corp (763 HK, Buy) - Q&A about Tower company and 4G capex ZTE Corp (763 HK, Buy) - 1Q14 review: 4G capex finally kicked in CCS (552 HK, Buy) - Forecast update; maintain Buy Comba Telecom Systems (2342 HK, Buy) - 2014 may remain challenging

Smart Home Skyworth (751 HK, Buy) - Positive on smart TV user growth China Smart Home - TCL focuses on TV games and O2O China Smart Home - Midea targets 30% Smart revenues by 2016 China Smart Home - Gree thinks “Smart” is still too early The Nomura Nomad Diaries - Smart Home: a bigger deal than smartphone?

IT Security & IT Nationalism SMIC (981 HK, Neutral) - Maintain Neutral at HKD0.68 Digital China (861 HK, Reduce) - 3Q14 review: still feeling pain of PRISM

Electric-Vehicle & Smart Drive BYD (1211 HK, Buy) - 1Q14 review: EV sales finally kicked in BYD (1211 HK, Buy) - BJ auto show: Denza is an entry-level Tesla BYD (1211 HK, Buy) - Raise TP by 28%; Buy for EV inflection point Tianneng Power (819 HK, Buy) - The worst is almost over Sunny Optical (2382 HK, Buy) - Positive from US vehicle safety policy

Smartphone/PC Value Chain China smartphone - What’s wrong? TCL Com (2618 HK, Neutral) - 1Q14 review: smartphone remains strong Sunny Optical (2382 HK, Buy) - March data and Amazon’s 3D smartphone Sunny Optical (2382 HK, Buy) - Looking beyond handset camera module BYD Electronic (285 HK, Buy) - Raising TP by 70% to price-in Nokia X upside Lenovo (992 HK, Neutral) - Investors’ concerns remain; maintain Neutral Lenovo (992 HK, Neutral) - Downgrade to Neutral

Nomura | China smart devices 21 May 2014

Stocks fall into the themes

Fig. 76: Company exposure to investment themes in 2014

4G 3D Information Air Pollution e-commerce 4G CAPEX Smartphones Smart TVs Smart Home Vision/Smart Security & IT & EV & Logistics Ticker Company Names Rating and Exports Drive Nationalism

Source: Nomura estimates

Fig. 77: Peer valuation table Code Company Trading Account Price Target M/Caps Nomura P/E ( x ) P/BV ( x ) ROE Dividend Curncy Curncy 15-May Price USD mn Rating FY13 FY14F FY13F FY14F FY14F Yield(%) China Technology 992 HK Lenov o HKD USD 8.9 9.0 11,936 Neutral 14.3 11.9 3.6 3.0 27% 1.5 1211 HK BY D HKD CNY 40.6 64.0 14,440 Buy na 50.4 3.5 3.3 7% 0.0 763 HK ZTE HKD CNY 14.3 20.0 6,818 Buy 17.8 14.2 1.7 1.7 12% 0.0 552 HK CCS HKD CNY 3.6 5.00 3,252 Buy 7.3 6.3 0.9 0.9 14% 4.8 981 HK SMIC HKD USD 0.64 0.68 2,661 Neutral 14.2 20.4 1.1 1.0 5% 0.0 2382 HK Sunny Optical HKD CNY 8.9 10.0 1,262 Buy 17.5 12.4 2.5 2.2 19% 1.5 285 HK BY D Elec tronic s HKD CNY 4.5 6.8 1,311 Buy 12.6 8.1 0.9 0.9 11% 0.0 AMAP US AutoNavi USD USD 20.9 19.0 1,451 Buy na na 2.0 2.3 -14% 0.0 861 HK Digital China HKD HKD 7.1 9.0 998 Reduce 5.6 6.2 1.0 0.9 15% 5.9 819 HK Tianneng HKD CNY 2.7 6.5 383 Buy 3.9 3.0 0.7 0.6 21% 9.0 2369 HK Coolpad HKD HKD 3.9 2.4 1,058 Neutral 17.7 13.6 2.9 2.5 20% 1.0 2342 HK Comba HKD HKD 2.1 3.8 417 Buy 8.3 6.3 0.8 0.7 12% 0.0 2618 HK TCL Com HKD HKD 8.2 7.8 1,262 Neutral 37.8 11.2 3.6 2.9 29% 0.0 751 HK Sky w orth HKD HKD 3.8 6.0 1,373 Buy 7.0 6.1 0.9 0.8 14% 3.8 China Tech Median 13.4 11.2 1.4 1.3 14% 0.5 941 HK China Mobile HKD CNY 75.90 80.0 198,269 Neutral 10.1 10.8 1.6 1.4 14% 3.66 762 HK China Unic om HKD CNY 12.00 13.5 36,835 Buy 21.9 14.6 1.0 1.0 7% 1.00 728 HK China Telec om HKD CNY 3.97 3.5 41,449 Neutral 14.8 12.8 0.9 0.9 7% 1.72 Telecom Median 14.8 12.8 1.0 1.0 7% 1.7

Source: Bloomberg, Nomura estimates

Nomura | China smart devices 21 May 2014

China Technology industry forecast summary

Fig. 78: China Smartphone market forecasts

China Smartphones Market Forecast 2011 2012 2013 2014F 2015F 1Q13 2Q13 3Q13 4Q13 1Q14 AAANOMNOM Total Smartphones (CATR based) 95 253 422 469 550 98 116 104 105 89 y-y 168% 67% 11% 17% 138% 115% 44% 21% -9% % of total handsets 23% 55% 73% 75% 81% 74% 74% 70% 75% 88% Sum of Three operators 95 220 360 410 450 China Mobile 30 60 155 180 200 China Telecom 15 60 75 75 80 China Unicom 50 100 130 155 170 Non-operator (0) 33 62 59 100 4G Smartphones 120 200 % of total smartphones 26% 36% China Mobile 80 120 China Telecom 10 20 China Unicom 30 60 Total Smartphones (Gartner based) 78 178 331 367 431 71 79 91 90 64 y-y 129% 86% 11% 17% 110% 101% 91% 58% -9% % of handsets 17% 44% 76% 87% 90% 65% 72% 82% 84% 86%

Source: CATR, Gartner, Nomura estimates

Fig. 79: China telecom industry capex summary

Y-Y Change CNY bn FY11 FY12 FY13 FY14F FY15F FY14F FY15F AAANOMNOM China Telecom industry CAPEX 333 361 384 425 389 Y-Y7%8%6%11%-9% China Mobile (group) 160 173 215 249 203 16% -18% China Telecom (group) 72 73 80 80 80 0% 0% China Unicom (group) 77 100 73 80 90 9% 13% Others 25 16 16 16 16 0% 0% Total Mobile 131 142 135 169 182 26% 7% 2G 76 59 33 8 0 -75% -100% 3G 55 82 66 39 27 -41% -31% 4G 0 0 35 122 155 246% 27% Fixedline broadband 111 143 153 149 136 -3% -8% Infrastructure/Others 91 77 96 107 71 11% -34%

Source: Company disclosure, Nomura estimates

Nomura | China smart devices 21 May 2014

Industry value chain charts

Fig. 80: China Smartphone and Tablet value chain

Handset Added value in the mobile phone business Component AAC Acoustics (2018 HK) Truly ((732 HK) Sunny Optical (2382 HK) BYDE (285 HK) Largan (3008 TT) Tongda (698 HK) Goertek (002241 CH) Ju Teng (3336 HK) O-Film (002456 CH)

Contents/Service Handset Software Handset OEMs Operator Provider

Google (GOOG US) OEM: China Mobile (941 HK) ALL service: Google, Apple, Microsoft Apple (APPL US) ZTE (763 HK) China Telecom (728 HK) Digital Map: AutoNavi (AMAP US), NavInfo Microsoft (MSFT US) Huawei (unlisted) China Unicom (762 HK) (002405 CH) TCL Com (2618 HK) Music: A8 (800 HK) China Wireless (2369 HK) Game: VODone (82 HK) Handset IC Lenovo (992 HK) Industry: Digital China (861 HK) Xiaomi (unlisted) Internet: Baidu (BIDU US), Alibaba (unlisted), Qualcomm (QCOMUS) Tencent (700 HK) MediaTek (2454 TT) ODM/EMS Spreadtrum (SPRD US) BYD Electronics (285 HK) RDA Microelectronics (RDA US) Foxconn (2038 HK) GalaxyCore (unlisted) Handset Design house OmviVision (OVTI US) Longcheer (LHK SP) Intel (INTC US) Sim Technology (2000 HK)

Source: Nomura research

Fig. 81: China Telecom Equipment Value chain

Optical Fibre Preform Optical Fibre Telecom software

Corning (GLW US) Hengtong Photoelectric (600487 CH) AsiaInfo-Linkage (ASIA US) Furukawa (5801 JP) Zhongtian Tech (600522 CH) Digital China (861 HK) Sumitomo Electric Industries Changfei (600345 CH) Amdocs (DOX US) (5802 JP) Futong (unlisted) Fujikura (5803 JP)

Optical Component Optical Network Optical Network

JDSU (JDSU US) Finisar (FNSR US) Huawei (unlisted) Accelink (002281 CH) Alcatel-Lucent (ALU US) ZTE (763 HK) O-Net (877HK) Oclaro (OCLR US) Fiberhome (600498 CH) UT Starcom (UTSI US) Oplink (OPLK US) Operators

Antenna and Wireless Network RF Sub-System Wireless Network China Telecom (728 HK) China Unicom (762 HK) GrenTech (GRRF US) Huawei (unlisted) China Mobile (941 HK) Sunwave (002115 CH) Ericsson (ERICB SS) Beijing Gehua CATV (600037 CH) MOBI-antenna (unlisted) Alcatel-Lucent (ALU US) Fingu (002194 CH) Nokia-Siemens-Network Powerwave (PWAV US) (unlisted) Andrew (unlisted) ZTE (763 HK)

Wireless Enhancement

Comba (2342 HK) GrenTech (GRRF US) Construction Service Sunwave (002115 CH) CCS (552 HK)

Source: Nomura research

Nomura | China smart devices 21 May 2014

Fig. 82: Smart Home value chain

Smart Home Controller (MCU) HeT和而泰 (002402 CH) Hodgen 和晶科技 (300279 CH) Yitoa 英唐智控 (300131 CH) Eastsoft 东软载波 (300183 CH) Hollysys 和利时 (HOLI US)

Router and Home Appliance Communication Network Cloud Service OEM Module ZTE 中兴通讯 (763 HK) Haier 海尔 (1169 HK, 600690 CH) China Mobile (941 HK) Tencent (700 HK) Huawei 华为 (unlisted) Hisense 海信 (600060 CH, 921 HK) China Unicom (762 HK) LeTV 乐视 (300104 CH) Xiaomi 小米 (unlisted) Gree 格力 (000651 CH) China Telecom (728 HK) BoomSense 邦讯 (300312 CH) Midea 美的 (000527 CH) UNIS 紫光 (000938 CH) Skyworth 创维 (751 HK) China Lihe 力合集团 (000532 CH) Lenovo 联想 (992 HK) Star-Net 星网锐捷(002396 CH) TCL (000100 CH, 1070 HK)

Security Module

HikVision 海康威视 (002415 CH) Anjubao 安居宝 (300155 CH) JSST 捷顺科技 (002609 CH) Gosuncn 高新兴 (300098 CH)

Source: Nomura research

Fig. 83: Smart TV enablers

Chip Qualcomm,MStar

TV OEM Skyworth, TCL, Hon Hai, TPV, (assembly, branding, Wistron, Samsung, Haier, Hisense, channel) Konka, Panda, Changhong Hardware Samsung, LGD, Sharp, AUO, TV Panel Chimei, CSOT, Chimei, BOE

OS: Google, Microsoft Software UI: LeTV, Skyworth, Hisense, Xiaomi, Alibaba, Lenovo Smart TV IPTV License holder CNTV, BesTV, SMC, CIBN, Enabler Wasu, CNBN, GBS Service IPTV content Youku, PPLive, LeTV, Voole, providers iQIYI

Telecom service China Telecom, China Unicom, operator Gehua, Topway Network Infrastructure Telecom Equipment Cisco,Huawei, Juniper vendor Network, ZTE, ALU

Source: Nomura research

Nomura | China smart devices 21 May 2014

Fig. 84: Lithium-ion battery value chain Electric Car : Toyota(7203 JP),Nissan : BYD(1211 HK), : Tesla (TSLA US) China Chery(unlisted), Geely(175HK), GAC(2238 HK), Dongfeng(489 HK), SAIC(600104 CH) US Japan (7201 JP) Battery System Desay (000049 CH) Battery Pack Management Management Simplo (6121 TW) China: Battery Cell Panasonic (6752 JP), Sony (6758 LGC (051910SDI KS), (006400 KS) (1211BYD HK), Lishen (unlisted), Japan: JP), TDK (6762 JP) Korea: China: (CBAK US), CBAK ATL (unlisted),Coslight (1043HK), CH),EVE(300014 Wanxiang(000559 CH), Ube Industry (4208JP), Guotai(002091 CH), Anode Nichia(unlistd), Solution Cathode Asahi Kasei(3407Asahi JP), Separator Electrolyte China: Japan: Mitsubishi Chemical (4188JP) Hitachi Chemical(4217 JP), Shanshan(600884 CH), Foshan plastic(000973 CH) Easpring (300073 CH), China: Shenzhen BTR(000009 CH’s subsidiary) Japan: Nippon Carbon (5302 JP), China: International: Toray-Tonen (unlisted), Celgard (PPO US); Ube(4208 JP) China: Citic Guoan (000839 CH), Shanshan (600884 CH), International: Umicore(UMITanaka ; BB) Chemical (4080 JP), Cobalt Lithium KantoDenka Kogyo (4047JP) : DFD: Chem (002407 CH), Jiujiujiu Electrolyte China: Tibet Mineral(000762CH) Japan: Stella Chemifa (4109 JP) China Technology (002411 CH) Source: Nomura research

Nomura | China smart devices 21 May 2014

Fig. 85: Summary of China companies in IC design, foundry, and packaging/testing Top 10 IC design houses in China Ranking Ticker Company Name 企业名称 2012 Revenue (CNY mn) 1 Private HiSilicon 深圳市海思半导体有限公司 7,420 2 SPRD US Spreadtrum 展讯通信有限公司 4,380 3 RDA US RDA 锐迪科微电子（上海）有限公司 2,460 4 Private CIDC 中国华大集成电路设计集团有限公司 1,610 5 600460 CH Silan 杭州士兰微电子股份有限公司 1,260 6 Private GalaxyCore 格科微电子（上海）有限公司 1,180 7 Private Leadcore Technology 联芯科技有限公司 1,170 8 Private SMIT 深圳市国微科技有限公司 1,120 9 VIMC US Vimicro 北京中星微电子有限公司 1,100 10 Private CEC Huada Electronic Design Co. 北京中电华大电子设计有限责任公司 940 Private Allwinner Technology * 全志科技 923 8102 HK Fudan Microelectronics 上海复旦微电子 704 Private Rockchip * 瑞芯微电子 646 002049 CH Tongfang Guoxin Electronics 同方国芯电子 582 Mont US Montage 澜起科技 481 300077 CH Nationz Technologies 国民技术 416 MEMS US MEMSIC 美新半导体 403 ACTS US Actions Semiconductor 炬力集成电路设计有限公司 334 300139 CH Fuxing Xiaocheng Electronic 福星晓程 291 300236 CH Shanghai Sinyang Semiconductor 上海新阳 264 300327 CH Sino Wealth Electronic 中颖电子 264 300053 CH Orbita 珠海欧比特 160 300223 CH Ingenic 北京君正 106 Private AMLogic 晶晨半导体 na

Top 10 IC foundries in China Ranking Ticker Company Name 企业名称 2012 Revenue (CNY mn) 1 000660 KS SK Hynix Semiconductor SK海力士半导体（中国）有限公司 13,780 2 INTC US Intel (Dalian) Semiconductor 英特尔半导体（大连）有限公司 12,560 3 981 HK SMIC 中芯国际集成电路制造有限公司 10,680 4 Private Huahong Grace Semiconductor 华虹宏力半导体制造有限公司 3,600 5 598 HK CR Microelectronics 华润微电子有限公司 3,520 6 2330 TT TSMC (China) 台积电（中国）有限公司 3,420 7 002129 CH Zhonghuan Semiconductor 天津中环半导体股份有限公司 2,540 8Private HeJian 和舰科技（苏州）有限公司 1,350 9 600360 CH Sino-Microelectronics 吉林华微电子股份有限公司 1,060 10 BCDS US BCD Semiconductor Manufacturing BCD 半导体 901 3355 HK ASMC 上海先进半导体 854 600171 CH Shanghai Belling 上海贝岭 676

Top-10 packaging and testing service providers in China Ranking Ticker Company Name 企业名称 2012 Revenue (CNY mn) 1 INTC US Intel Product (Chengdu) 英特尔产品（成都）有限公司 18,840 2 Private Xinchao Group 江苏新潮科技集团有限公司 6,650 3 FSL US Freescale Semiconductor (China) 飞思卡尔半导体（中国）有限公司 6,490 4 Private Weixun United Semiconductor 威讯联合半导体（北京）有限公司 4,500 5 600584 CH Changjiang Elec. Tech 长电科技 4,429 6 Private Nantong Huada Microelectronics 南通华达微电子集团有限公司 4,130 7 Private Hitech Semiconductor 海太半导体（无锡）有限公司 3,390 8 6752 JP Panasonic Semiconductor (Shanghai) 上海松下半导体有限公司 3,370 9 Private Samsung Semiconductor (Suzhou) 三星电子（苏州）半导体有限公司 2,370 10 Private Renesas Semiconductor 瑞萨半导体（北京）有限公司 2,320 IFX US Infineon (Wuxi) 英飞凌科技（无锡）有限公司 2,300 002185 CH Tian Shui Hua Tian Technology 天水华天科技 1,619 002156 CH Nantong Fujitsu Microelectronics 南通富士通 1,590 002079 CH Good-Ark 苏州固锝电子股份有限公司 805

Note: FY12 revenue is based on data from CSIA (China Semiconductor Industry Association) Source: Company data, Nomura estimates (*)

Nomura | China smart devices 21 May 2014

Appendix A-1

Analyst Certification

We, Leping Huang and Da Zhao David Hao, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures

The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers

Issuer Ticker Price Price date Stock rating Previous rating Date of change Sector rating BYD 1211 HK HKD 39.35 20-May-2014 Buy Neutral 19-Apr-2013 N/A Comba Telecom Systems 2342 HK HKD 2.11 20-May-2014 Buy Not Rated 29-Sep-2010 N/A China Wireless Technologies 2369 HK HKD 3.75 20-May-2014 Neutral Not Rated 24-Jan-2011 N/A Sunny Optical 2382 HK HKD 9.15 20-May-2014 Buy Neutral 18-Oct-2013 N/A TCL Communication Tech 2618 HK HKD 7.35 20-May-2014 Neutral Buy 14-Aug-2012 N/A BYD Electronic 285 HK HKD 4.53 20-May-2014 Buy Neutral 20-Feb-2013 N/A Largan Precision 3008 TT TWD 1,960.0 20-May-2014 Buy Neutral 05-Nov-2012 N/A China Telecom 728 HK HKD 3.92 20-May-2014 Neutral Buy 08-Jan-2014 N/A Skyworth 751 HK HKD 3.76 20-May-2014 Buy Not Rated 04-Nov-2013 N/A China Unicom 762 HK HKD 11.40 20-May-2014 Buy Neutral 11-Feb-2010 N/A ZTE Corp 763 HK HKD 13.98 20-May-2014 Buy Neutral 26-Oct-2012 N/A Tianneng Power 819 HK HKD 2.60 20-May-2014 Buy Not Rated 08-Aug-2012 N/A Digital China 861 HK HKD 7.07 02-May-2014 Reduce Buy 20-Jun-2013 N/A China Mobile 941 HK HKD 78.05 20-May-2014 Neutral Buy 16-Mar-2012 N/A SMIC 981 HK HKD 0.64 20-May-2014 Neutral Buy 07-Jun-2013 N/A Lenovo Group 992 HK HKD 9.13 20-May-2014 Neutral Buy 05-Feb-2014 N/A

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Nomura | China smart devices 21 May 2014

Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 45% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 42% of companies with this rating are investment banking clients of the Nomura Group*. 44% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 54% of companies with this rating are investment banking clients of the Nomura Group*. 11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 26% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 March 2014. *The Nomura Group as defined in the Disclaimer section at the end of this report.

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Nomura | China smart devices 21 May 2014

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