China Payment

Sector Research

China Payment China / TMT The Rise of NFC Payment 12 May 2016 We believe mobile payment will be the next battlefield for Internet giants, UnionPay, and smartphone OEMs as consumer transactions are shifting from PC end to mobile devices rapidly. 2016 will be an inflection point where NFC payment adoption will finally accelerate following UnionPay’s heavy investment and its partnerships with OEMs. We prefer PAX Global over Goldpac given its position as the key potential beneficiary of the mobilisation trend.

Partnership with OEMs to Boost NFC adoption China payment is a highly competitive, innovative and cross-border integrated industry. In response to the rapid adoption of Alipay and Tenpay, China UnionPay aggressively started to make significant investments in mobile payment and choose new partners since late 2015. We believe UnionPay’s partnership with Sector Performance (%) smartphone OEMs, notably Apple and Samsung, will ultimately drive the NFC 450 Pax Global adoption in China. We reviewed the security concepts related to mobile payment 400 in this report and believe Apple Pay offers the safest security structure, followed 350 by UnionPay’s QuickPass and Samsung Pay. We expect 2016 to be the inflection 300 250 point where penetration rate of NFC mobile payment likely to accelerate. +87% 200

Distinct Mobile Payment Adoption Path in China 150 HSI Index -12% In contrast to most of the street discussion, we believe China will forge its own 100 development path in mobile payment, distinct from that in US, Europe, and 50 -60% Goldpac Korea/Japan. We expect higher NFC adoption in well-developed Tier 1/2 cities 0 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 where card penetration is higher while Tier 3 and below cities could jump directly Note: 1 Jan 2014 = 100, Source: Bloomberg from cash to mobile wallets, skipping the card phase. Implications for stakeholders can be mixed depending on their roles in the evolving ecosystem with merchants while consumers will likely be the long-term beneficiaries. We believe incumbents like banks and UnionPay’s position will be better off should NFC sees faster adoption. Alipay and Tenpay should remain unchallenged given their dominance in online payment.

Pax Global and Goldpac Jackson Yu, CFA We highlight two payment leaders listed in Hong Kong, PAX Global (327 HK, BUY, SFC CE No.: AUX358 TP: 9.1) and Goldpac (3315 HK, NEUTRAL, TP: 3.1). Despite its moderating growth, +852 2899 6773 [email protected] we believe the potential NFC adoption should help PAX Global’s volume in China and EMV migration in the US is still its growth engine in the next couple of years. Christopher Tse We forecast Pax Global’s revenue and core earnings to grow 14%/17% CAGR in SFC CE No.: BAZ779 +852 2899 6768 FY16-18. We transfer coverage of PAX to Christopher Tse with unchanged BUY [email protected] rating and a new DCF-derived target price of HKD9.1 (47% upside), which implies 16x FY16F P/E. We are less positive on Goldpac as we believe card manufacturers Zhenghao Jiang SFC CE No.: BGL257 are most challenged in the mobile payment migration as we expect a slowing card +852 2899 6774 volume growth going forward. Initiate Neutral with TP of HKD3.1 based on 8x [email protected] FY16F P/E.

Figure 1: Valuation Comparison Market EPS Price P/E P/B Yield ROE Cap CAGR Stock BBG HKD USDm % FY16F FY17F FY15 FY16F FY16F FY17F FY16F FY17F Pax Global 327 HK 6.21 893 16.6 10.8 9.4 2.7 3.3 0.0 0.0 19.1 18.3 Goldpac 3315HK 3.01 323 5.0 7.7 7.4 1.2 1.1 3.7 3.8 15.1 14.5 Source: Company Data, Bloomberg, Guosen Securities (HK) Research

See the last page of this report for important disclosures 1

行业报告

中国 / 行业中国支付行业 2016 年 5 月 12 日

NFC 支付市场壮大随着中国消费者的交易付款方式迅速由电脑终端转移至移动设备，我们相信，移动支付市场将会成为各大互联网巨头、银联以及智能手机 OEM 厂商的兵家必争之地。银联大额注资移动支付业务，并且与 OEM 厂商合作，将有助提升 NFC 支付的应用率，2016 年将会是中国支付行业的一个拐点。百富环球是整个支付行业进化的主要受惠者，因此相对金邦达，我们较看好百富环球。

与 OEM 厂商合作推动 NFC 应用中国支付行业是一个竞争激烈、创新和跨板块的综合一体式行业。为应对支付宝和财付通迅速渗透市场，中国银联积极反击，自 2015 年底开始大额注资股价表现发展移动支付以及寻求新合作伙伴。我们认为银联与智能手机 OEM（原始设 (%) 备制造商）厂商的合作关系（尤其是与苹果和三星）将有助推动 NFC 在中国 450 Pax Global 市场的应用。我们在本报告中评论了移动支付所涉及的保安概念，认为 Apple 400 Pay 的安全度最高，其次是银联的 QuickPass 和三星的 Samsung Pay。我们预 350 期，随着 NFC 移动支付的渗透率加速增长，2016 年将会是行业的一个拐点。 300 250 +87% 中国移动支付市场的独特发展路向 200 与市场上的主流论调不同，我们认为中国的移动支付市场将会开创出独特的 150 HSI Index -12% 发展路向，有别于美国、欧洲和韩国／日本市场。我们预期，在银行卡渗透 100 率较高的一二线发达城市，NFC 的应用率相对较高。至于在三线和更次级城 50 -60% Goldpac 市，消费者支付方式可能跳过银行卡阶段，由现金直接转为手机钱包。这发 0 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 展路向对利益相关者的意义是难以断定的，因为需要视乎在不断演变的生态系统中，各利益相关者与商户之间的关系，而消费者很大机会是长远的受益注：2014 年 1 月 1 日=100，资料来源：彭博方。我们相信，目前正在提供相关服务的银行和银联，较能受惠应用率 NFC 的加速增长，同时预料支付宝和财付通在线上支付领域的龙头地位将可维持稳固。俞励颉, CFA 百富环球和金邦达证监会中央编号:AUX358 +852 2899 6773 我们重点研究香港上市的两大支付业务龙头：百富环球（，买入，目 327 HK [email protected] 标价：9.1 港元）和金邦达（3315 HK，中性，目标价：3.1 港元）。尽管百富环球增长放缓，我们认为 NFC 应用的增长潜力有助带动公司在中国的业务表谢嘉熙现，而美国的 EMV 迁移将于未来数年持续为公司提供增长动力。我们预测百证监会中央编号: BAZ779 富环球 16-18 财年的收益和核心盈利将按年复合增长率 14%/17%增长。我们 +852 2899 6768 [email protected] 转让百富环球的覆盖予谢嘉熙，维持买入评级，按现金流折现计算的新目标价为 9.1 港元（上升空间 47%），相当于 16 财年预测市盈率 16 倍。我们对金姜正浩邦达较为保守，原因是预期银行卡发卡量的增速将会放缓，而从银行卡迁移证监会中央编号:BGL257 到手机支付的发展对银行卡制造商的冲击最大。我们对金邦达首予中性评级， +852 2899 6774 按 16 财年预测市盈率 8 倍计算，目标价为 3.1 港元。 [email protected]

Figure 2: 估值比较 Market EPS Price P/E P/B Yield ROE Cap CAGR Stock BBG HKD USDm % FY16F FY17F FY15 FY16F FY16F FY17F FY16F FY17F Pax Global 327 HK 6.21 893 16.6 10.8 9.4 2.7 3.3 0.0 0.0 19.1 18.3 Goldpac 3315HK 3.01 323 5.0 7.7 7.4 1.2 1.1 3.7 3.8 15.1 14.5

资料来源：公司资料、彭博及国信证券(香港)研究部

2 研究报告仅代表分析员个人观点，请务必阅读正文之后的免责声明。 2

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Table of Contents

Jackson Yu, CFA Executive Summary 7 SFC CE No.: AUX358 Key Stock Investment Thesis 8 +852 2899 6773 [email protected] Pax Global (327 HK, Buy, TP: 9.1) ...... 8 Goldpac Group (3315 HK, Neutral, TP: 3.1) ...... 8 Christopher Tse SFC CE No.: BAZ779 The Payment Landscape in China 10 +852 2899 6768 Electronic Payment Overview ...... 10 [email protected] Online Payment Landscape ...... 13 Zhenghao Jiang SFC CE No.: BGL257 Mobile Payment Landscape ...... 14 +852 2899 6774 Key Mobile Payment Drivers ...... 16 [email protected] NFC Payment Likely to Take Off 20 Why merchants love third parties? ...... 20 Alipay and Tenpay’s Value Chain Disruption ...... 20 Apple Pay: Gaining Traction in China ...... 21 What about Android phones? ...... 21 Can Apple Pay and Samsung Pay accelerate the NFC payment adoption? ...... 24 More Cooperation With Major Domestic OEMs ...... 25 Expect NFC Adoption to Accelerate in 2016-18 ...... 25 Creating new payment scenarios – a major challenge for NFC ...... 26 MNO’s past trials ...... 27 Safety Focus – The Top Concern for Mobile Payment 28 The Difference between SE NFC and HCE NFC ...... 28 HCE NFC Infrastructure ...... 30 SE NFC Infrastructure ...... 31 Is NFC more secured than QR code? ...... 32 China’s Mobile Payment Future ...... 35 Future Development Path ...... 35 Advantaged and Disadvantaged Players in the Evolving Landscape ...... 36 Appendix A: Major Mobile Payment Solutions in China ...... 38 Appendix B: Mobile Payment Deployment Models ...... 39 Appendix C: Global Smartphone Shipment ...... 39

Company Page

Pax Global ...... 47 Goldpac Group ...... 64

Important Disclosures ...... 91

All prices quoted in this report are as at close of 11 May 2016.

Guosen Securities (HK) 3

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Focus Charts

Figure 3 Total Third-party Payment Transaction (Online and Offline) Figure 4 Traditional Four Corner Electronic Payment Model (Rmb trn) (%) 60 55 30 China Issuer Acquirer UnionPay 50 47 25 42 Network Fee 40 36 20 Rmb0.065 32 Rmb99.5 30 26 15 Issuer Fee: Acquirer Fee:

Rmb100 Rmb0.35 Rmb0.085*

20 10

Rmb100 Rmb99.5 Merchant Discount 10 5 Customer Merchant Rate 0.5% 0 0 2010 2011 2012 2013 2014 2015F Rmb100 purchase transaction Third-party Payment Transaction % YoY

Source: Analysys, iResearch, Guosen Securities (HK) Research Source: Guosen Securities (HK) Research

Figure 5 Third-party Mobile Payment Transaction Figure 6 Alipay Leads Third-party Mobile Payment Market Share (3Q15) (Rmb trn) (%) Lianlianpay 20 18.3 100 Lakala 1.4% Union 18 90 Tenpay 6.0% 16.0% MobilePay 16 14.7 80 1.3% 14 70 Ping An Pay 11.4 0.7% 12 60 Qiandai 0.7% 10 8.4 50 UnionPay 0.5% 8 40 6.0 Easy Bill 6 30 Pay 0.5% 4 20 0.2% Yeepay 2 1.2 10 0.1 0.2 0.3% Alipay 0 0 71.5% Others 2011 2012 2013 2014 2015F 2016F 2017F 2018F 0.9% Third-party Mobile Payment Transaction % YoY

Source: Analysys, Guosen Securities (HK) Research Source: Analysys, Guosen Securities (HK) Research

Figure 7 Mobile Has Become Main Portal to Shop Online Figure 8 UnionPay NFC-enabled POS As % of Total POS (%) (m units) (%) 100 25 40

90 35 80 38 20 45 41 30 70 54 67 15 25 60 86 50 99 94 20 40 10 15 62 30 55 59 10 5 20 46 33 5 10 15 0 0 0 2 6 2011 2012 2013 2014 2015F 2011 2012 2013 2014 2015F 2016F 2017F 2018F NFC-enabled POS (RHS) Non-NFC POS (RHS) Mobile PC NFC POS Penetration (LHS) Source: iResearch, Guosen Securities (HK) Research Source: PBoC, UnionPay, Guosen Securities (HK) Research

Guosen Securities (HK) 4

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Glossary of Terms

CBRC China Banking Regulatory Commission, the main regulatory body of financial institutions in China

China UMS The merchant acquirer subsidiary under China UnionPay

EMV Europay, MasterCard and Visa, i.e. a global chip-card standard that is designed to enhance card security over conventional magnetic stripe card

HCE Host card emulation is the software architecture that provides exact virtual representation of various electronic identity (access, transit and banking) cards using only software.

Interchange Fee Transaction fee paid by merchants to card issuing banks

Issuer Issuing banks of debit/credit cards to consumer, charge fees on each transaction

Merchant Acquirers Parties that prepares a merchant to accept certain payment method and authorise the payment transaction

MNO Mobile Network Operators, i.e. China Mobile, China Unicom and China Telecom

Mobile Wallet Mobile phone app that is used to process electronic transaction at the POS

Network operators China UnionPay, Visa, Master, the payment organisation that connect and accept transaction from the banking cards

NFC Near Field Communications, short-range communication system based on RFIC technology that allows secure payment data transfer between devices.

O2O Online-to-offline commerce is a new business strategy that draws potential customers from online channels to physical stores.

P2P Peer-to-peer lending, sometimes abbreviated P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders directly with borrowers.

PBoC People's Bank of China, China's central bank

POS Post of Sale, the hardware terminal used in stores that facilitate the payment transaction

QR Code Quick Response Code, the two dimensional bar code that can be sued to transmit data, including payment and user credential information

RFID Radio-frequency Identification. Wireless communication using electromagnetic/radio waves.

SE Secure Element, a physical chip element on a mobile phone, can be SIM, chip or SD card that encrypts and authenticate payment details.

SIM A subscriber identity module or subscriber identification module (SIM) is an integrated circuit chip that is intended to securely store the international mobile subscriber identity (IMSI) number and its related key, which are used to identify and authenticate subscribers on mobile telephony devices (such as mobile phones and computers).

Tokenisation A process that transfer sensitive user data into a proxy encrypted identifiers to reduce fraud risk

TSM Trusted Services Manager, a third party in the NFC payment model that services as a contact point between payment solution provider and NFC mobile phones

TSP Token Service Providers, services providers for tokenisation

Guosen Securities (HK) 5

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Mobile Payment Ecosystem

Issuer Payment Networks Acquirers Merchants

UnionPay ICBC UnionPay CCB Visa (China UMS) LaneCrawford ABC MasterCard Alipay Carrefour BOC Tenpay Joy City Lakala NGS Supermarket LianlianPay Urban Revivo Lotus MNOs China Union Mobile Pay LotteMart POS Vendors Ping An Pay YeePay McDonald KFC China Moile PayEase Burger King China Unicom PAX Global China Telecom New Land 7 Eleven Xinguodu Lawson Verifone mCommerce, Social, FamilyMart Ingenico Search Kedi NCR Alldays Smartphone OEMs OK Store Tmall Manning Taobao Apple JD Pacific Cofee Samsung COSTA Card Vendors Suning Huawei Vipshop Haagen-Dazs Xiaomi Jumei Godiva Dangdang Wechat/Weixin SG Fruit Goldpac Didi Kuaidi CityShop.com Hengbao Meituan EF Education Wuhan Tianyu Software Vendors Wechat Movie Chutian Dragon Tuniu . G&D Qunar . Gemalto Apple Ctrip . China Notes Google Baidu Monitise

Source: Guosen Securities (HK) Research

Guosen Securities (HK) 6

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Executive Summary

UnionPay has started to China payment is a highly competitive, innovative and cross-border integrated industry. A clear response to online third line divided online and offline payment in the past. However, rapid increases in smartphone party payment players penetration, large mobile Internet user base and shifting consumer from PC to mobile are reshaping industry dynamics and creating new opportunities for new players. We believe mobile payment is disruptive to incumbents (like China UnionPay and banks) in the traditional offline payment space. Leveraging on their strong presence in online social and eCommerce sector, Internet players have gained substantial user adoption on Quick Response (QR) code payment given seamless and ubiquitous payment experience. In response, offline payment incumbents such as China UnionPay (UnionPay) have also started to make significant investments in mobile payment.

Partnership with OEMs We believe UnionPay’s partnership with smartphone OEMs, notably Apple and Samsung, will should boost NFC payment drive the NFC adoption in China. For instance, launched in Feb-2016, Apple Pay offers a adoption seamless user experience, proven record in enhancing value propositions, high-security protection to users and lower fees scheme. This may solve most of the problems related to past NFC deployment models and likely enjoy fast adoption in China in the next few years. UnionPay began aggressively choosing new partners since late 2015, deciding deployment models and offering promotions to merchant clients to gain more traction. Benefiting from UnionPay’s existing penetration on brick-and-mortar retailers, we expect Apple Pay to be successful in China. Despite the challenges in creating new payment scenarios, we think NFC fit nicely with UnionPay-led NFC payment models, with SE NFC or HCE NFC becoming the country standards, and potentially starting to win some share from cards and third-party payment players. We believe 2016 will be the inflection point where penetration rate of mobile payment with NFC likely to accelerate.

Security is the key concern Security is the single most important factor affecting user adoption. In the report, we review while the safer NFC should security concepts, concerns as well as known technologies behind of NFC models in China. help to address it. Fingerprint tokenisation is important as it validates a “card present” transaction. We believe Apple Pay offers the safest security structure, followed by UnionPay’s QuickPass and Samsung Pay. Quick QR code is generally considered to be less secure than NFC payment, and its security risks were highlighted by the PBoC in Mar 2014. Nevertheless, payment is always a balance between security with provisioning, sustainability and business model. Given the high adoption of QR code payment, there is almost no way to stop it in the near term.

China should embrace In contrast to most of the street discussion, we believe China will forge its own development mobile payment in its own path in mobile payment, distinct from that in US, Europe, and Korea/Japan. We expect higher way.. NFC adoption in well-developed Tier 1/2 cities where card penetration is higher while Tier 3 and below cities could jump directly from cash to mobile wallets, skipping the card phase. Implications for stakeholders can be mixed depending on their roles in the evolving ecosystem with merchants while consumers will likely be the long-term beneficiaries. Banks and UnionPay’s position will be better off should NFC sees faster adoption. MNOs such China Mobile and China Telecom are most challenged after UnionPay’s deployment model and its partnership with OEMs. Alipay and Tenpay remain unchallenged given their dominance in online payment.

We keep BUY on Pax Global We highlight two payment leaders listed in Hong Kong, PAX Global (327 HK, BUY, TP: 9.1) and but initiate Goldpac with Goldpac (3315 HK, NEUTRAL, TP: 3.1). Despite its moderating growth, we believe the potential Neutral rating NFC adoption should help PAX Global’s volume in China and EMV migration in the US is still its growth engine in the next couple of years. We are less positive on Goldpac as we believe card manufacturers are most challenged in the mobile payment migration as we expect a slowing card volume growth going forward. Details of our investment thesis are highlighted on the next page.

Guosen Securities (HK) 7

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Key Stock Investment Thesis Pax Global (327 HK, BUY, TP: 9.1) Analyst: Christopher Tse / +852 2899 6768 /[email protected] Jackson Yu, CFA / +852 2899 6773 / [email protected] Zhenghao Jiang / +852 2899 6774/ [email protected]

We transfer coverage of PAX to Christopher Tse. We keep BUY with a new DCF-derived target price of HKD9.1 (36% upside), which implies 16x FY16F P/E. We forecast revenue and core earnings to grow 14%/17% CAGR in FY16-18F. Drivers in FY16 will continue to be EMV migration in the US, while China and Brazil enter a slower growth phase. We also build in a 12% payment services income mix by FY20 (conservative given peers’ 30-35% in FY15) and see upside from a faster-than-expected ramp up. We believe 327 HK’s recent share price downtrend reflects investors’ growth expectations of China and Brazil markets, both of which have been disappointing. However, with the long term trend of increasing adoption in new emerging markets, we believe overseas markets will very likely be the main sales and earnings driver in the future. As PAX’s overseas sales mix increase, we believe the stock should re-rate closer to Ingenico’s and Verifone’s multiples in the long run.

Goldpac Group (3315 HK, NEUTRAL, TP: 3.1) Analyst: Jackson Yu, CFA / +852 2899 6773 / [email protected] Zhenghao Jiang / +852 2899 6774/ [email protected] Christopher Tse / +852 2899 6768 /[email protected]

We initiate Goldpac with Neutral rating and TP of HKD3.1. We believe China is less likely to reach developed countries’ level in the long term. Mobile payment is disruptive to cards as we expect card penetration has reached saturation in most Tier 1/2 cities while in Tier 3 and below regions, people adopts mobile payment directly by skipping card payment. Incorporating a replacement cycle for existing card installed base, we expect new IC cards in China will grow at 15%/13% in FY16/17 down from 34%/24% in FY14/15. We model Goldpac’s IC card volume to grow at 12% CAGR in FY15-18, a much slower growth compared to 74% CAGR in FY12-15. We see increasing newcomers entered the payment banking card market in the past few years. Despite unstable order flow from banks, these new players have diluted the market share of existing industry players in the past few years. In particular, as the industry leader, Goldpac’s market share has come down from 21% in 2013 to 19% in 2014 and 15.5% in 2015. We expect the industry competition remains fierce in FY16-18 as newcomer grasped market by lower ASPs. We expect Goldpac’s earnings growth to slow in FY16-18 given a. increasing competition with newcomers entering the market, b. volume growth may slow the given the disruptive impact from mobile payment and c. overseas business should need some time to take off. We forecast its net profit CAGR to slow from 36% in FY12-15 to 5% in FY15-18.

Please refer to our Company Page for more details.

Guosen Securities (HK) 8

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 9 Valuation Comparison Company Ticker Price Mkt Cap EPS CAGR P/E P/B ROE Yield Lcy (USDm) % 16F 17F 15 16F 16F 17F 16F 17F

POS Vendors

PAX Global 327 HK 6.21 893 16.6 10.8 9.4 2.3 1.9 18.9 18.7 N/A N/A Ingenico ING FP 102.20 7,126 17.8 21.6 18.8 4.1 3.6 16.6 16.9 1.4 1.5 Verifone PAY US 26.83 2,957 14.2 12.0 10.5 3.6 3.2 23.0 27.5 N/A N/A Average 16.2 14.8 12.9 3.3 2.9 19.5 21.0 0.5 0.5

Card Vendors

Goldpac 3315 HK 3.01 323 7.0 7.7 7.4 1.2 1.1 15.1 14.5 3.7 3.8 Gemalto GTO NA 57.24 5,832 48.9 14.2 12.4 2.0 N/A N/A 13.5 N/A 0.9 Average 28.0 10.9 9.9 1.6 1.1 15.1 14.0 3.7 2.4

A-share Listed Peers

Hengbao 002104 CH 14.61 1,604 25.6 20.3 17.2 6.5 5.3 24.6 24.5 N/A N/A Tianyu 300205 CH 12.36 818 N/A 112.2 58.8 4.7 N/A 4.1 N/A N/A N/A EastCompeace 002017 CH 12.43 664 N/A N/A N/A 5.2 N/A N/A N/A N/A N/A Xinguodu 300130 CH 24.58 875 29.3 49.2 37.8 N/A N/A 8.4 10.1 0.8 0.9 Average 27.5 60.5 37.9 5.5 5.3 12.4 17.3 0.8 0.9

BAT

Tecent 700 HK 155.10 187,991 30.3 29.6 23.0 N/A 6.1 N/A 26.5 N/A 0.5 Baidu BIDU US 173.94 60,227 -6.9 26.1 19.5 4.1 3.5 N/A 17.9 0.0 0.0 Alibaba BABA US 79.20 196,092 2.8 24.5 19.2 5.0 3.8 21.2 19.9 0.0 0.0 Average 8.7 26.7 20.6 4.6 4.5 21.2 21.5 0.0 0.2

Banks

ICBC 1398 HK 3.96 217,027 2.8 4.4 4.2 0.6 0.6 14.8 13.2 8.0 7.1 CCB 939 HK 4.74 153,688 2.8 4.4 4.3 0.7 0.6 15.2 13.5 7.8 6.9 ABC 1288 HK 2.69 149,357 1.5 4.2 4.1 0.6 0.5 14.3 12.8 8.2 7.3 BOC 3988 HK 3.02 138,756 3.0 4.4 4.3 0.6 0.5 13.1 11.7 7.7 6.9 Average 2.5 4.4 4.2 0.6 0.5 14.3 12.8 7.9 7.1

Source: Bloomberg, Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 9

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

The Payment Landscape in China

Summary. We think mobile will be the key battleground for Alipay, Tenpay, UnionPay and other stakeholders in 2016-18. In this section, we review China payment industry and size the transaction volume for the card, online, and mobile payment.

Electronic Payment Overview After years of rapid growth, online payment is now a mature market dominated by Alipay, UnionPay and Tenpay. We think the payment battlefield among internet giants and offline players will move on to smartphone devices, replacing cash and cards. Dozens of companies are trying to gain support from merchants and users to become their top choice. To Internet companies, O2O is the key word they mention when moving offline. They view smartphones as the future gateway to complete their ecosystem and achieve monetization. But for most of the offline payment players, like banks, merchant acquirers, and UnionPay, offline is their bread-and-butter business. They have to make the final decisions such as technology adoption, choosing partners as well as deployment models to catch up to the mobilisation train to protect their market share. Stakeholders: PBoC and UnionPay are the centres of China's payment ecosystem as these incumbents provide payment clearing and settlement. The four-party electronic payment system in China is similar to US and Europe albeit strict regulation by the state. Merchants act as product and services providers. Issuers are mostly commercial banks such as ICBC, CCB, and ABCI. They charge transaction fees from merchants. Payment network operators provide interbank transaction settlement. UnionPay is the dominant player in China. Visa and Master still await further regulatory approval on details after they were allowed to enter the market in mid-2015. Merchant acquirers authorise the transactions and charge transaction fees from merchants. Main acquirers in China include some commercial banks, China UMS (UnionPay's subsidiary) and other third-party payment acquirers, including AliPay and Tenpay.

Figure 10 Major Stakeholders of China Payment Industry

PBoC CBRC Payment & Clearing Association Other Regulatory bodies

Debit/Credit Card Acquirers Hardware Manufacturers Third-party Payment Facility Telecom Operators telecom (Offline) Prepaid Card Acquirers networks Merchant Acquirers Agents

Commercial Banks Third-party Payment Third-party Online Payment Payment Processing & (Online) Acquirers PBoC Clearing Central Clearing System Build and operate Facilitate bank accounts and electronic payment Provide online payment Third-party Mobile Payment other non-cash payment gateways for netizens and online China UnionPay system and provide vehicles such as check, bills merchants. Acquirers payment clearings. and debit/credit cards

Users Merchants

Source: iResearch, Guosen Securities (HK) Research

Guosen Securities (HK) 10

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Card payment. Card transaction is driven by, a) the secular transition in consumer spending habits to card payments from cash and b) rising disposable income over the long term. We estimate card accounted for roughly 25% of the total payment transaction in China, after 60-70% of the cash-based transaction. By end-2015, there were 5.4bn debit and credit cards issued by banks. The total number of card transaction amounted 29bn in 2015, representing a CAGR of 43% in 2010-15. Aggregate card spending reached Rmb55trn in 2015, representing a CAGR of 39% in 2010-15. Given low penetration of credit cards in China, we estimate debit cards accounted for over 70% of card transaction volume, followed by credit cards' 29% and prepaid cards' 1%. Average card transaction declined sequentially in the past few years to Rmb1,803 in 2015 due to higher card penetration and cannibalisation from online eCommerce upon brick-and-mortar retailers. Merchants discount rate, the percentage fee that merchants pay to banks, acquirers, and UnionPay, was about 0.38 to 1.25% in China. Banks (usually take 70%), merchant acquirers (20%) and network operators (10%) further share the fee. To boost the card payment and retail consumption, PBoC's latest policies released on 18 March 2016 revised down the merchant discount rate: banks' cut was capped at 0.35% for debit cards and 0.45% for credit cards with an absolute amount cap of Rmb13 per transaction. UnionPay's take was lowered to 0.065% with a cap of Rmb6.5 per transaction. Based on PBoCs new policy, merchant discount rate should save merchants' total expenses by Rmb7.4bn per annum. For catering and other services industry, where merchants are entitled the highest discount rates before, can pay 53%-63% less from Sep 2016. Convenient stores and department stores can pay 23-39% less.

Figure 11 Outstanding Debit and Credit Card in China Figure 12 Debit/Credit Card Spending vs Per Transaction Spending (bn) (Rmb trn) (Rmb) 6 60 3,000 5.4 4.9 2,800 5 50 2,600 4.2 2,400 4 3.5 40 2,200 2.9 3 5.0 30 2,000 2.4 4.5 1,800 3.8 20 2 3.2 1,600 2.7 2.2 1,400 1 10 1,200 10 15 21 32 42 55 0.4 0.5 0.4 0 0.2 0.3 0.3 0 1,000 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Card: Consumer spending Per Transaction Spending Credit card Debit card Source: PBoC, Guosen Securities (HK) Research Source: PBoC, Guosen Securities (HK) Research

Guosen Securities (HK) 11

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 13 Card Payment Fee Breakdown

Parties Fees New Policy (Effective from Sep 2016) Old Policy (Effective from Feb 2013) Catering& Consumer Consumer Services Discretionary Staples Utilities Merchant Acquirers Collected from (e.g. Banks, UnionPay, Fully marketerised 0.22% 0.15% 0.08% 0.00% rd merchants 3 -party acquirers)

Collected from < 0.35% Issuers (e.g. Banks) 0.90% 0.55% 0.26% 0.00% merchant acquirers (Capped at Rmb13/transaction) Network Operators Collected from < 0.065% (e.g. UnionPay, Visa, issuers and 0.13% 0.08% 0.04% 0.00% (Capped at Rmb6.5/transaction) Master) merchant acquirers Total 0.42% excl. merchant acquirers' take 1.25% 0.78% 0.38% 0.00%

Source: PBoC, Guosen Securities (HK) Research

Figure 14 Four-party Card Payment Ecosystem

China Issuer Acquirer UnionPay

Network Fee

Rmb0.065 Rmb99.5

Issuer Fee: Acquirer Fee:

Rmb100 Rmb0.35 Rmb0.085*

Rmb100 Rmb99.5 Merchant Discount Customer Merchant Rate 0.5%

Rmb100 purchase transaction

Note *: Assumed merchant acquirers’ take. Source: Guosen Securities (HK) Research

Third-party payment. Except banking channels and UnionPay, PBoC also issues licenses to third-party companies to conduct payment related business. The number of licensees increased from 101 in 4Q11 to 268 as of Dec 2015. Those players can carry out merchant acquiring, online/offline payments, prepaid cards, mobile payments, etc. Third-parties played a major role in securing online and offline transaction in the past few years. They were acting like an escrow in the small-ticket transaction and effectively reduced fraud risks. Analysys estimated total third-party volume, including brick-and-mortar offline transactions, online and mobile, was Rmb55trn in 2015, up 17% YoY. Third-party online volume reached Rmb49trn in 2015, up 100% YoY. China UMS, a subsidiary owned by UnionPay, is the dominating player in offline acquiring business and holds about 35% share, followed by Alipay and Tenpay.

Guosen Securities (HK) 12

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 15 Total Third-party Payment Transaction (Online and Offline) Figure 16 Major Third-party Payment Market Share (Online and Offline, 4Q15) (Rmb trn) (%) 60 55 30 China PnR 5% Others 50 47 25 10% 42 China 40 36 20 99Bill UnionPay 32 6% 35% 30 26 15 Tenpay 20 10 10%

10 5

0 0 2010 2011 2012 2013 2014 2015F Alipay 34% Third-party Payment Transaction % YoY Source: Analysys, iResearch, Guosen Securities (HK) Research Source: Analysys, Guosen Securities (HK) Research

Figure 17 Most Frequently Used Payment Method Figure 18 % of Respondents That Have Used These Payment Gateway

Best Pay 3.8 Online banking 9% Cash on UnionPay 15.3 delivery 13% Online banking 17.4

Tenpay 64.2 Thrid-party /Wechat pay payment 78% Alipay 90.7

0 20 40 60 80 100 (%)

Source: iResearch, Guosen Securities (HK) Research Source: iResearch, Guosen Securities (HK) Research

Online Payment Landscape

Alipay dominates online Internet giants have gained substantial share in third-party gateways through their major e- third-party payment commerce and social networking platforms in the past few years. Players like Alipay, Tenpay, industry and Baidu wallet grew tremendously following their parent companies' growing resources and strategic directions. Alipay and Tenpay had big increases in market shares in 4Q14 and 4Q15 following the online and offline consumption boom on the Single Day promotion campaign (11 Nov). Analysys estimated the volume for online third-party payment industry to reach Rmb14trn in 2015, up 55% YoY, driven by eCommerce, online game, and travels. Alipay was a payment product launched by Alibaba more than a decade ago when internet banking was not even created in China. The payment gateway at that time was built to address security concern among buyers and sellers on the online transaction. After years of rapid growth, China's eCommerce GMV reached USD670bn in 2015 as the world largest market, within which Alibaba's GMV was about USD500bn.

Guosen Securities (HK) 13

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Tenpay leverages on Tencent's huge user base on social networking platforms. Combined Wechat and Weixin MAU reached 697m in 4Q15, more than half of the country's population. Tencent launched the red envelope initiatives in 2014 as gifting vehicles during Chinese New Year. The volume exchanged via Wechat Pay exceeded 32bn within 6 days of the holiday, growing by 9 times year-on-year. QQ Wallet gained popularity with 6bn red envelopes exchanged via QQ Wallet at the same period.

Figure 19 Third-party Online Payment Transaction Volume Figure 20 Market Share of Major Internet Payment Gateway (4Q15) (Rmb trn) (%) 40 160 China PnR Others 34 7% 35 140 9%

30 27 120 9 Bill 25 100 20 7% Alibaba 20 80 45% 14 15 60 China UMS 14% 9 10 40 6 4 5 2 20 1 Tenpay 0 0 18% 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F Third-party Online Transaction Volume % YoY Source: Analysys, Guosen Securities (HK) Research Source: Analysys, Guosen Securities (HK) Research

Mobile Payment Landscape We classify mobile payment into two major categories: a) remote payment technologies used in mobile commerce and P2P transfer or direct transfer of funds, and b) proximity payment, including QR codes and NFC.

Two key categories of Remote Payment. Using MNO's network, remote payment builds a bridge between users: mobile payment smartphone and a payment system using technologies of SMS, GPRS, or WAP. To send a payment request and complete a payment, users can send a short message or access online payment gateway through browsers or dedicated apps. After the payment system receives payment requests from smartphones, payment will be processed. Proximity Payment. Using wireless technologies including QR, RFID, and Bluetooth, a smartphone can be equipped with near field payment functionality. Through either scanning the QR code or integrating an NFC chip into an SIM or smartphone, users' smartphone can interact with merchant terminals, such as QR readers, NFC readers, and contactless-enabled POS terminals, to finish the payment processes. NFC can be made without using the mobile internet.

Guosen Securities (HK) 14

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 21 Major Mobile Payment Technologies Mobile Payment Technology

Proximity Remote

Barcode NFC mCommerce P2P

QR code used for fulfilment of NFC payment system such as NFC payment system such as P2P transfer or direct transfer of transactions by scanning a code Apple Pay, Samsung Pay and Apple Pay, Samsung Pay and funds either from a bank using the camera UnionPay Quick Pass UnionPay Quick Pass account directly or from stored value wallets held in the form of credit currency

Source: IDC, Guosen Securities (HK) Research

Alipay dominates mobile Third-party mobile payment. Based on the survey conducted by iiMedia Research, third-party payment industry payment is the most preferred payment method when consumers shop on smartphones. Among all payment apps, Alipay is the most frequently used payment gateway. Analysys estimated the total market size of mobile payment to reach Rmb8.4trn in 2015, up 40% YoY from Rmb6trn in 2014. The mobile payment gateway is dominated by Alipay, which took 72% market share in 2015, followed by Tenpay's 16%. Over the past few years, Alipay and Tenpay strengthened the effort to attack and invest in offline payment scenarios such as taxi, restaurants, convenient stores, movie ticketing etc, which put pressure on card payment market and its stakeholders, such as UnionPay and some offline acquirers. Most of the offline acquirers are making efforts to protect their market share and build their own ecosystem. For instance, Lakala, one of a leading offline player, entered mobile payment market earlier last year with POS terminals and focused on offline convenient stores, communities and glossary stores. In the past two years, Lakala also entered P2P financing with new services in credit reference, personal loans, and wealth management products on top of its payment business. Lakala achieved a cumulative transaction volume of Rmb120bn in its personal loans business and a volume of Rmb5bn per month in wealth management business.

Market share of UnionPay is UnionPay was a slow mover in the evolution of mobile payment in the past. Despite the robust thin growth of China's mobile payment industry, UnionPay merely holds 0.5% market share in terms of transaction volume. However, we expect market share gains for UnionPay following the deployment of its own payment solution, UnionPay QuickPass, as well as its collaboration with smartphone OEMs, such as Apple Pay, Samsung Pay, Huawei and Xiaomi.

Guosen Securities (HK) 15

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 22 Third-party Mobile Payment Transaction Figure 23 Alipay Leads Third-party Mobile Payment Market Share (3Q15) (Rmb trn) (%) Lianlianpay 20 18.3 100 Lakala 1.4% Union 18 90 Tenpay 6.0% 16.0% MobilePay 16 14.7 80 1.3% 14 70 Ping An Pay 11.4 0.7% 12 60 Qiandai 0.7% 10 8.4 50 UnionPay 0.5% 8 40 6.0 Easy Bill 6 30 Pay 0.5% 4 20 0.2% Yeepay 2 1.2 10 0.1 0.2 0.3% Alipay 0 0 71.5% Others 2011 2012 2013 2014 2015F 2016F 2017F 2018F 0.9% Third-party Mobile Payment Transaction % YoY

Source: Analysys, Guosen Securities (HK) Research Source: Analysys, Guosen Securities (HK) Research

Key Mobile Payment Drivers

We identify several key Mobile Internet is disruptive to PC-based business as consumers get connected 24/7 hours mobile payment drivers seeking data, products, and services anywhere/anytime. Smartphone devices will pay a pivotal role in enabling commerce in both online and offline world. We highlight a few worth noting factors that should drive the mobile payment adoption in the coming few years.

Favourable infrastructure Large mobile Internet user base. Based on IDC estimates, 434m new smartphones were shipped to China in 2015, the highest quarter ever in history. Smartphone penetration reported a rapid growth in the past few years. Nielson estimated 62% of the country population owned at least one smartphone and the ratio reached 94% in Tier-1 cities. CNNIC estimated China had over 620m mobile Internet users as of Dec 2015, representing 91% of total Internet users. Based on Umeng, including tablets, there were a billion active mobile devices in China in 3Q15. Penetration of 3G/4G networks. China's 3G/4G subscriber base increased dramatically over the past few years as total counts reached 756m in Dec 2015, according to MIIT. Monthly subscription growth accelerated in 2014-15 as MNOs like China Mobile, China Unicom, China Telecom aggressively added new 3G/4G subscriptions, indicating a trend that further penetration ahead.

Figure 24 China Smartphone Penetration (2014) Figure 25 Number of Active Mobile Device (m unit) (%) 94% 120 12

108 75-88% 110 106 10 103 99 100 8 90 90 6 32-88% 83 80 4

70 2

60 0 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Tier 1 Tier 2 Tier 3 and below Number of Active Device % QoQ Source: Nielson, Guosen Securities (HK) Research Source: Umeng, Guosen Securities (HK) Research

Guosen Securities (HK) 16

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 26 China Mobile Internet User Growth Figure 27 3G/4G Subscription (m) (%) (m) (%) 700 100 900 180 620 819 90 759 600 557 800 160 80 500 700 140 500 70 593 120 420 600 60 100 400 356 500 303 50 80 300 400 233 40 60 300 233 200 30 40 118 200 20 128 20 100 50 10 100 0 0 0 0 -20 2007 2008 2009 2010 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Mobile Internet User % of Internet User 3G/4G Subscription % YoY

Source: CNNIC, Guosen Securities (HK) Research Source: MIIT, Guosen Securities (HK) Research

Shifting consumer habits Changing consumer behaviour. Consumers in China have built a track record of fast adoption to new technologies. China consumers are much more advanced in mobile commerce compared to the rest of the world. Based on PwC's consumer survey, China leads the world in purchasing via mobile devices. Among 900 consumers in China that PwC surveyed, 77% purchased from mobile devices, 47% shopped on a tablet and 51% on a smartphone at least once a month, versus a global average of 22% and 21%. The survey also shows despite sharing the same security concern, Chinese consumers are much more willing to use mobile payment, store personal information in an app, and load credit into a smartphone than global peers. 63% of the respondents are fine with storing private payment and delivery information on their smartphones, over a double the rate of US consumers. From the same survey, 55% of Chinese respondents said they expect the mobile device to become the main tool for future purchasing. The new generation of consumers, the millennium (under the age of 20) are the most Westernized and open to new products. These consumers pursue individualism and often use the Internet to follow global trends. Though most in this group do not yet earn a significant income, they materially influence their parents' decisions on food, clothing, electronics, and other purchases. Mobile social media is an effective marketing tool to reach this group of consumers.

Figure 28 Consumer Experience in Mobile Payment

23%

Global 43% China Average 57%

77%

Yes NO Source: PwC report, “Achieving Total Retail” 2014, Guosen Securities (HK) Research

Guosen Securities (HK) 17

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 29 Chinese consumers are much more willing to use mobile payment or store data on their phone Please indicate how strongly you agree or disagree with the following statement. (%) 85 79 75 71 66 63 65 56 53 55 55

45 33 35 31 29 25

15 Happy to receive Wary of personal Happy to store Willing ot load credit My mobile phone will offers or coupons via credit information payment and delivery onto my phone to become my main tool mobile phone hacked when using information in an app provide payment for for which to purchase mobile phone on my phone phones itmes Source: PwC report, “Achieving Total Retail” 2014, Guosen Securities (HK) Research eCommerce and O2O The evolution of eCommerce and O2O. Mobile commerce recorded a tremendous growth as accelerates adoption Internet giants incent users to move from PC to mobile. iResearch estimated eCommerce from the mobile devices grew 23% YoY to Rmb520bn in 3Q15 and total mobile commerce is expected to reach Rmb1.8trn 2015. China's mobile commerce has also eclipsed that in the US, with total sales outnumbering the U.S.'s penetration. Based on eMarketer and iResearch, mobile commerce in China hit a global record high in 2015, accounting for 50% of all e-commerce in the country, with projections for 2019 setting the percentage of mobile commerce transactions at 71.5% of all online retail. In contrast, eMarketer expects mobile commerce will total 22% of all online sales in the U.S. in 2016. By 2019, eMarketer predicts the percentage of the mobile front will inch up to 28%. We believe the seamless shopping experience that Internet giants provided are disruptive to offline traditional retailers. Mobile commerce where users can shop anything anywhere and anytime forces offline brick-and-mortar players to upgrade all facets of the value chain so as to differentiate. Some premature examples are emerging as small offline retailers collaborate with online internet portals over inventory, order fulfilment, advertising and promotion while mobile payment will play a pivotal role in closing the loop.

Figure 30 Mobile Commerce Reported Tremendous Growth Figure 31 Mobile Has Become Main Portal to Shop Online (Rmb bn) (%) 5,000 100 4,504 4,500 90 80 38 4,000 3,728 45 41 70 54 3,500 67 2,835 60 3,000 86 50 99 94 2,500 40 1,809 2,000 62 30 55 59 1,500 20 46 930 33 1,000 10 15 500 274 0 2 6 12 69 2011 2012 2013 2014 2015F 2016F 2017F 2018F 0 2011 2012 2013 2014 2015F 2016F 2017F 2018F Mobile PC Source: iResearch, Guosen Securities (HK) Research Source: iResearch, Guosen Securities (HK) Research

Guosen Securities (HK) 18

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Merchants benefits form big Transaction-enabling to merchants. Using Alipay and Tenpay, merchants are able to obtain data provided by Alipay & more information about their customers (such as their spending behaviour, preference, Tenpay geographic locations etc.), while conventional payment acquirers failed to offer those value added services. Internet company's data analytics enables merchants to offer more targeted promotions and advertising through mobile devices without additional investments in marketing. We believe this presents opportunities to reach their target customers and accelerates the merchant adoptions on mobile payment.

Figure 32 Taobao’s Merchant Services Market (LINK)

Source: Taobao, Guosen Securities (HK) Research

Guosen Securities (HK) 19

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

NFC Payment Likely to Take Off

Summary. We expect Apple Pay/Samsung Pay to kick-start what has been a slow-going NFC ecosystem in China, in particular on users and merchant fronts. We think other smartphone OEMs such as Xiaomi and Huawei in the Android ecosystem will embrace NFC technology in the coming few years. We anticipate payment infrastructure upgrades to accelerate, leading to a steeper ramp up of NFC penetration and a market share gain for UnionPay.

Why merchants love third parties? With the seamless purchase experience, high smartphones penetration and underdeveloped banking infrastructure in rural China, third-party acquirers gained substantial market share in the online and offline space. A few considerable reasons for merchants to welcome third-party companies are: Firstly, Compared to developed markets like US and Europe, China retail space is still immature and fragmented. Most of the premature retailers are still in the early stage of the development, and most of them tend to prefer cash-only in the past. UnionPay's past strategy has been focusing on those large merchants, basically offering a substantial but underpenetrated SME market to Internet companies. Secondly, the barrier for card payment is high. Despite a much lower fee taken by banks, acquirers, and UnionPay in China compared to that in the US, SMEs are still sensitive to those payment discount costs. Therefore, POS installation for banking cards is still low. Compared to UnionPay, Alipay and Tenpay usually offer lower installation cost for POS terminal and much attractive cut per transaction, at 0.2% (vs cards' 0.38-1.5%, thereby leading to a fast adoption of QR-code payment among small merchants. Thirdly, Alipay and Tenpay also give value-added services to merchants leveraging on their large usage base. Potential advertising and marketing on their social network channels can be vital to merchants. Those promotions together with data analytics services they provide give competitive advantages to merchants to stand out in their business scope. Alipay and Tenpay’s Value Chain Disruption

Alipay and Tenpay gains Since early 2014, Internet giants started to partner with offline players aiming to win in the while UnionPay and banks O2O at the embryonic stage. We believe the main impact that the proliferation of third-party loses payment brings to banks and UnionPay is the value disruption. Banks lost the sight of users transaction details as Alipay and Tenpay act like a prepaid card system when consumers add money to their digital wallet first. Additional market share erosion is taking place as Alibaba and Tencent offer wealth management products such as deposits like products (Yu-e Bao), lending (Ant Micro Loan) and internet banking system (My Bank) to users to fortify their ecosystem. To other offline acquirers (including China UMS, the subsidiary of UnionPay), they kept losing market share to Alipay and Tenpay in the past given their less attractive value added services, user offering and fee mechanism.

Guosen Securities (HK) 20

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

UnionPay faces threats To UnionPay, increasing QR code payment has eroded the offline market share traditionally maintained by UnionPay. Tencent and Alibaba's dominances in online space basically redistributed the current fee structure of the value chain, i.e. commission fees from merchants, banks, and acquirers. Without the involvement of UnionPay, Alipay and Tenpay are able to offer much lower fee scheme for merchants. Given the current macroeconomic environment and the momentum of the mobilisation, backed by Internet giant's user base, it is a matter of time for traditional large offline merchants to adapt to the new O2O world and join Internet giant's camp if UnionPay does not provide suitable mobile payment solutions for them. Apple Pay: Gaining Traction in China UnionPay cooperates with We believe the cooperation with Apple Pay was major fight back from UnionPay which aimed Apple to fight back to win market share from third-party payment leaders like Alipay and Tenpay. Apple Pay was first announced in 2014 as an NFC-based, Touch ID-protected payment system for iPhone 6. The service went live with the release of iOS 8.1, later expanding to Apple Watch and in-app payments on Touch ID-equipped iPads. On February 18, 2016, Apple Pay is launched in mainland China with a current and planned support of 19 largest banks in China. Apple's regional website states 15 banks are part of its launch. With Apple's initial slate of partners, powered by UnionPay processing, 80 percent of China's credit and debit cards can be provisioned for use on Apple Pay. On the retail end, Apple highlighted about one-third of all merchants capable of processing UnionPay cards will also be able to accept Apple Pay payments. On the list of supporting stores are 5Star.cn, Mannings, Lane Crawford, all days, Carrefour and the usual players Apple Store, McDonald's, Burger King, 7-Eleven, KFC and more. On Zhihu, China's Quora-like forum, Apple Pay owns 1000 followers, versus QuickPass's 50 subscribers and Samsung Pay's 100. In the Baidu Index, which tracks the relative search popularity of keywords, a comparison of Apple Pay, Samsung Pay and QuickPass indicates Apple Pay had a sudden surge in Feb 2015 after its launch. Most of the topic centered on how to insert/bounding cards into Apple Pay. What about Android phones? NFC extends to Android Android space is fragmented with hundreds of OEM-makers on open source Android OS. In phones contrast to iOS, where Apple fully integrates hardware and software with control over both hardware and software, Android users spread across distinct software versions. This created the barrier for compatibility of new mobile solutions. Different levels of hardware specification for Android handsets in terms of processing power, memory, NFC functionality, and the Secure Element increase the challenge of payment standardization.

Figure 33 Active Device Breakdown By OS (3Q15) Figure 34 Apple Global Shipment Growth

Windows ('000) (%) 3% 5,800 9 5,600 8 5,400 7 iOS 35% 5,200 6 5,000 5 4,800 4 4,600 3 Android 4,400 2 62% 4,200 1 4,000 0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Shipment (LHS) Market Share (RHS) Source: iResearch, Guosen Securities (HK) Research Source: IDC, Guosen Securities (HK) Research Guosen Securities (HK) 21

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

On top of its self-developed payment solutions, UnionPay QuickPass, UnionPay cooperated other smartphone OEMs like Samsung, Huawei and Xiaomi on NFC deployment. As iOS merely accounted for about 30% of total smartphone base, this should enlarge NFC compatible base to the other 70%. Samsung Pay. In early March16, Samsung Pay started rolling out across China with supports from 9 banks. The payment service is available for the Samsung Galaxy S7, Galaxy S7 Edge, Galaxy S6 Edge+ and Galaxy Note 5 devices, with the "opportunity to support additional mid- range models in the future", the company adds. Consumers who use Samsung Pay can make secure mobile payment via almost all existing POS terminal. This compatibility is a key feature, made possible through its Magnetic Secure Transmission (MST): a new proprietary technology that makes Samsung Pay usable in merchant location regardless of whether the POS supports NFC or magnetic stripe cards. This was obtained through its acquisition of LoopPay in 2015, through which Samsung had the access to the MST. Two major differences compared to Apple Pay are, a. Samsung Pay works at almost all stores that accept credit or debit cards, not just those with tap-to-pay NFC terminals; b. Samsung Pay users need to unlock the phone and select the card they wish to use before tapping the phone to the POS terminal. UnionPay QuickPass. In Dec15, UnionPay launched its HCE-based QuickPass in Beijing with over 20 banks in China, officially enters offline battles. In the offline payment scenarios, consumers can pay not only with its cards but also via its mobile solution, QuickPass. UnionPay QuickPass product is based on HCE and Token technologies. This supports most of the Android smartphones with NFC functions (coupled with Android 4.4.2 operating system or above). Thereby the smartphone can be used to make tap-and-go payments at UnionPay's NFC-supported POS terminals with PIN input required. HCE-based payment also stores most of the user credentials in the cloud instead of on mobile devices. We think this can be a key technology and ultimate for the mass Android platform users. Compared to Alipay and Tenpay, UnionPay's QuickPass claims to be safer with multiple security features such as cryptographic keys and cloud verification. The card number will not be revealed at the POS or to the merchants. It also offers better user experience as it does not require Internet access or opening an app. QuickPass is available at over ten thousand locations of 25 franchise chains in mainland China, including Carrefour, McDonald's, Watsons, FamilyMart, and COSTA with exclusive offers for QuickPass users.

Guosen Securities (HK) 22

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 35 Supported OEM Models for UnionPay QuickPass by Dec 2015 OEM Model OEM Model Galaxy Grand Prime Xperia Z1 Galaxy S4 Xperia Z2 Galaxy S5 Xperia Z3 Sony Galaxy S6 Xperia Z5 Galaxy S6 Edge Xperia M5 Galaxy S6 Edge+ Xperia T2 Ultra Galaxy Note4 MOTO X Pro XT1115 Motorola Galaxy Note4 Edge MOTO X XT1085 Samsung Galaxy Note5 HTC Desire 816 Galaxy E7 HTC Desire 826 HTC Galaxy A8 HTC ONE M8 Galaxy J5 HTC ONE M9 Galaxy J7 LG LG G3 Beat Galaxy A9 (2015) OPPO 3007 Galaxy S7 OPPO OPPO N3 Galaxy S7 Edge OPPO Find 7 Y635 Lenovo A380t Honor Changwan 4 Lenovo Lenovo A805e Huawei MATE2 Lenovo S860e

MATE7 Meizu Meuzu PRO5

Qingyang 2 VIVO VIVO X520L Qingyang 3 Xiaomi 3 ZTE Xiaomi AXON Xiaomi 5 Q802C

Source: UnionPay, Guosen Securities (HK) Research

Figure 36 Android Phone Market Share by Brand

4Q15 17 15 8 8 5 5 5 2 2 34

4Q14 23 12 8 5 7 5 6 1 3 32

Samsung Xiaomi Huawei Vivo Lenovo OPPO Coolpad Meizu ZTE Others

Source: Umeng, Guosen Securities (HK) Research

Guosen Securities (HK) 23

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Can Apple Pay and Samsung Pay accelerate the NFC payment adoption?

We believe working with Yes, we think Apple Pay and Samsung Pay would accelerate the NFC payment adoption in OEMs could boost NFC China. Upon Apple Pay formally entering China market, the standardization of the NFC adoption technology finally settled. Though a vast majority of the consumers are using QR code payment, we see ample upside from NFC adoption in China. Proven record in building its own ecosystem. Apple integrates every hardware and software components of its mobile phone into its own ecosystem. Most of the users who had Apple ID and App Store purchase experience already sign up their banking cards with their Apple ID. Consumers concerns over the payment security iOS device were addressed from the beginning. After 12 hours of its launch in China, Apple announced 3m UnionPay cards were activated and bundled with Apple Pay. With about 30% total shipment market share and 34% share in active smartphone device, we believe Apple Pay is able to receive fast adoption in the coming few years. Seamless user experience. Apple Pay offers a substantial uplift to the user experience. Some domestic online eCommerce companies such as Meituan, Dianping, Vipshop, and Dangdang announced to provide in-app purchase supports. After choosing Apple Pay, users only need to authenticate fingerprint thought the Touch ID sensor to complete the payment. This was a bit jump in user experience - much more simplified than Tenpay and Alipay when it needs to jump in and out of the current app. Tokenisation combined with Touch ID improves its security. Compared to other existing mobile wallets, Apple Pay relies on a secure element on its iOS mobile phone, an isolated chip that stores tokenised user credentials. In contrast to Alipay and Tenpay, Apple Pay cannot access to users' transaction data. We think this should help dispel one of the major concerns that issuers and UnionPay have regarding the data protection. Lower fees to gain supports. Apple Pay does not charge merchants for the payment transaction directly. Instead, it takes a minor fee share from banks. There is no disclosure on fee sharing arrangement from issuers while some press reports (Financial Times) highlighted issuers in the US are paying 15 bps from each transaction volume to Apple. Caixin reported Apple agreed with the first batch 19 banks on 7 bps per transaction or less than half of its charge in the US. This should eliminate any possible extra cost for merchants to accept Apple Pay.

Figure 37 Apple Pay Highlighted by Baidu Index

Source: Baidu, Guosen Securities (HK) Research

Guosen Securities (HK) 24

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

More Cooperation With Major Domestic OEMs YTD, UnionPay has Huawei announced to partner with UnionPay in late 2015 for the roll out of Huawei Pay, an expanded its partnership to domestic OEM leaders NFC-based mobile payment service that makes use of tokenization technology and is expected to be available for a wide range of Huawei handsets. The deal means UnionPay cardholders will be able to store their cards on their mobile device and pay with their Huawei handset at any contactless terminal. Xiaomi filed a patent in Korea in Mar 2015 for a mobile payment service called Xiaomi Pay according to a news report in Korea. The news speculates Xiaomi's upcoming mid-range smartphone MI5 will feature the NFC mobile payment service. In Apr 2016, Xiaomi announced to cooperate with UnionPay on future mobile payment deployment.

Expect NFC Adoption to Accelerate in 2016-18

There are a few false trails in the past for NFC payment in China including those payment solutions provided by telecom operators as SIM NFC was an expensive and complicated technology to deploy. Consumers need to upgrade their mobile SIM to NFC-enabled, while merchants need to bear the cost for new POS terminals, leading to a low merchant adoption. It also requires additional participants such as trusted services managers (TSMs) to balance the payment process.

We anticipate a NFC Alipay and Tenpay's mobile payment solutions are disruptive to incumbents, i.e. banks and adoption acceleration Unionpay. In contrast, Apple Pay and Samsung Pay do not affect the legacy four-party e- payment ecosystem while they provide a more convenient way for users to complete the payment process with enhanced security from data attacks. UnionPay is actively promoting Apple Pay and Samsung Pay aiming to win a higher bid in the final offline payment battle. We expect NFC adoption to accelerate in 2016-18 as we see three critical points that make differences this time. a. A growing NFC penetration in the payment terminal infrastructure is taking place under UnionPay's heavy investments. UnionPay's NFC-enabled POS terminals only accounted for less than 60% of total in China. b. Increasing NFC adoption in smartphones including both iOS and Android phones. Most of the latest Android smartphone series under domestic brands are NFC compatible.

Figure 38 UnionPay NFC-enabled POS As % of Total POS (m units) (%) 25 40

35 20 30

15 25 20

10 15

10 5 5

0 0 2011 2012 2013 2014 2015F NFC-enabled POS (RHS) Non-NFC POS (RHS) NFC POS Penetration (LHS)

Source: UnionPay, Apple, Guosen Securities (HK) Research

Guosen Securities (HK) 25

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

c. Apple Pay/Samsung Pay/QuickPass covered all existing NFC deployment model that incumbents like UnionPay and Banks, should give full supports within their ecosystem. d. Most importantly, unlike people in developed market, Chinese consumers have shorter adoption cycle when it comes to new technology. Consumer payment behavior changes rapidly, as evidenced by the tremendous growth of third-party mobile transaction in the past few years.

Figure 40 Comparison between Samsung Pay, Apple Pay and QuickPass Samsung Pay Apple Pay QuickPass Technology NFC NFC HCE-NFC

Latest models of Samsung Galaxy S7, S7 Apple iPhone 6/6 Plus, Samsung, Huawei, LG, Edge, S6 Edge+, Galaxy 6S/6S Plus, SE, Apple Handset ZTE, Sony, OPPO, Lenovo, Note 5, Galaxy S6 and S6 Watch, iPad Air 2, iPad Meizu and Xiaomi with Edge Pro and iPad Mini 3 and 4 Android 4.4.2 and above

Local payment Local payment Dynamic limited-use Risk management keys on SE keys on SE credential Issuers/Network APIs to scheme TSP APIs to scheme TSP operators implemented Provisioning Tokenised PAN and Static tokenized PAN Static tokenized PAN dynamic payment credentials Unlock phone, touch App on by default, touch Unlock phone, Transaction start home screen to wake home screen to wake, start app running Authentication Fingerprint or PIN Fingerprint (ToughID) PIN Works with NFC, Works with NFC Works with NFC POS magnetic stripe or EMV terminals and in-app terminals and in-app terminals purchases purchases Credit, debit and gift Credit, debit, selected Cards Credit, debit cards cards loyalty cards Bank supports 9 19 28

Source: UnionPay, Apple, Samsung, Guosen Securities (HK) Research

Creating new payment scenarios – a major challenge for NFC Looking for new payment Payment is all about consumer and merchant adoption. On the consumer side, most of the scenarios are big challenges to UnionPay daily small-ticket payment scenarios have been widely adopted by mobile users in China. As of 3Q15, Tenpay had 150m active users and Alipay had 190m active users. Compared to these two, UnionPay's large card base, however, is isolated from the Internet to some extent. We view building new payment scenarios for NFC payment as the largest challenge that UnionPay faces in the near future. Based on iClick's survey in 2015, online shopping, mobile phone bills, and money transfer were the three most used payment scenarios in China. Financial analysis, insurance, and cross-border transfer have been the least adopted scenarios. It is hard for consumers to change habits for those well-adopted scenarios as stickiness to payment gateways is usually high. For those emerging scenarios like entertainment, utility bill payment, wealth management products present opportunities for new players to enter the market and build up consumer adoption.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 41 Survey on usage on electronic payment in different payment scenarios (1Q15)

Cross Border Transfer 41 Emerging Payment Context Cover 40-60% users Insurance 48 Potential opportunitites for new payment gateways Financial Analysis 49 Skin Care 55 Game Purchase 55 Education 59 Utility Bill Payment 62 Semi-mature Payment Context Entertainment 62 Cover 60-70% users Lottery 66 Mid-to-high adoption in certain context Still have high potential in user penetration Personal Finance 69 Credit Card Repayment 72 Mature Payment Context Restaurant 74 Cover 70--90% users Airline Ticketing 83 Wide epayment adoption Existing spending behavior with high Money Transfer 92 loylty to certain services Mobile Bill Payment 93 Online Shoping 94

Note: Sample size =4114; Source: iResearch, Guosen Securities (HK) Research

MNO’s past trials

We believe MNO drived NFC China NFC payment development comes a long way. China Mobile, China Telecom, and China payment is less likely to Unicom - were active in the mobile payment industry in 2010-11. While NFC appears to be the gain traction consensus for hardware-based payments then, it was not easy for MNOs, UnionPay, OEMs and banks to reach collaboration and boost NFC together. For instance, the NFC standard was one of the key issues at that time. China Mobile looked into the contactless solution, known as RF- SIM, which uses a 2.4GHz frequency. The 2.4GHz standard SIM gives higher transmission power, allowing it to penetrate through a phone's battery; in contrast, the 13.56MHz standard adopted by UnionPay the other two MNOs was easier to deploy but requires users to purchase specific handsets with contactless payment capabilities built in. After aggressive promotions in 2010, including ordering over one million RF-SIM cards, in 2011 China Mobile joined the other two mobile operators and UnionPay in publically announcing support for the 13.56MHz NFC standard, indicating it has lost the ground on its own spectrum. Later in 2011-13, there was lots of discussions over its standards, solutions and revenue models while single successful deployment model implemented then. NFC and contactless payments remain the least-developed and most-discussed form of payment in China. Following Apple Pay, Samsung Pay, and UnionPay's deployment, we believe MNO's position as mobile payment solution provider is most challenged as the later three have cut out MNO's involvement in their ecosystems.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Safety Focus – The Top Concern for Mobile Payment

Summary. This section is for technology geeks. We expect a fast adoption of NFC following Apple Pay, Samsung Pay and QuickPass’s launch in China. We view Apple Pay as the safest solution on the back of its SE plus biometric authentication technologies. There were some discussions on security risks related QR code as highlighted by PBoC in Mar 2014. Nevertheless, payment is always a balance between security with provisioning, sustainability and business model. Given a high adoption of QR code payment, there is almost no way to stop it in the near term. We think payment methods in pecking order in terms of security are Apple Pay > QuickPass > Samsung Pay > QR code.

To the proliferation of Alipay, Tenpay, NFC or otherwise, payment security is always a huge concern to users, merchants, issuers, payment networks and any new solution provider. According to iResearch, security tops all concerns of users. We think any newsflow over security breach could substantially affect the adoption pace as consumers shift to other payment technologies.

Figure 42 Top Concerns of China Electronic Payment Users (2014) (%) 70 65 60 55 50 45 40 35 30 25 20 Online Banking Mobile Banking 3rd-party Online Payment 3rd-party Mobile Payment

Brand Convenience Price Function Safety Note: Sample size =4114; Source: iResearch, Guosen Securities (HK) Research The Difference between SE NFC and HCE NFC SE NFC – Hardware-based Figure 42/43 illustrates the difference between SE and HCE. For SE NFC, the payment app, HCE NFC – Cloud-based including the sensitive credentials, resides inside the Secure Element (SE) on the mobile handset. The SE is a physical element of the mobile phone (attached on its main chip, SIM or even SD card) that encrypts and authenticates payment details. It communicates with the NFC controller/antenna during the payment transaction process. The chip itself is similar with a standard EMV chip or SIM with high-security level. It can be owned by MNO or the handset OEM (Apple and Samsung's case) and others that offer the services through the secure applications that sit on the chip (such as banks, UnionPay etc). Google incorporated Host Card Emulation (HCE) with its release of Android 4.4. It provided a shortcut to previous NFC model as it allows the payment app located in the mobile phone operating system (i.e. held in software) to also communicate with the NFC controller/antenna. This cloud-based authentication allows app providers to load payment apps into the handset via an app store. This eliminates the need for a secure element and the involvement of the MNO, and thus reduces costs and complexity of the payment process.

Guosen Securities (HK) 28

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 43 SIM SE NFC Ecosystem Figure 44 HCE NFC Ecosystem

MNO Issuer MNO Issuer

MNO TSM SP TSM Issuer Host MNO TSM SP TSM Issuer Host

Secure Element Secure Element Payment Payment Network Network Consumer Consumer Device Device

Mobile App POS Usage Mobile App POS Usage

Provisioning & Management Provisioning & Management Consumer Consumer Merchant Merchant Source: Hyperion, Guosen Securities (HK) Research Source: Hyperion, Guosen Securities (HK) Research

Card present or not decides Card present vs. Card-Not-Present Transaction. It is important to understand that the the fee structures to potential fraud risk is an intrinsic cost in the four-corner transaction model. Merchant's fee to merchants the merchant acquirers and issuers were depending on the nature of the merchant business (as set by PBoC's previous fee structure policy released in 2013) and also the transaction nature, i.e. whether the card is swiped (magnetic stripe) or the card information is keyed in. Swipe-and-pay (or insert-and-pay for chip-based banking cards) is the typical card-present case as the merchant POS terminal verified the holders by checking the PIN and the signature. The issuing bank bears the fraud liability risk of the card present transaction. In contrast, during online (in-browser) or mobile purchases (in-app purchase), the details of the payment card is keyed in, which creates the card-not-present scenario, because merchants have no way to verify the cardholders' identity if there is fraud risk involved. Card-not-present transaction thus resulting in far more risks than the card-present transaction, giving issuers and merchants fraud liabilities, which in turn leads to in higher fees for everyone to bear. Strong vs. two-factor authentication. Strong authentication is a referring to authentication methods that require more security information than a standard set of card details or username/password combination. Strong and two-factor authentication is often used interchangeably, but technically they are different in meanings. Two-factor authentication is an additional layer of security. It is more secure than strong authentication because it requires one more variable to confirm identity and the physical possession of the card by the user. The main reason for two-factor authentication or even multi-factor authentication is to reduce fraud costs and increase the security level. On Jan 2013, the European Central Bank (ECB) issued mandatory guidelines that require all payment gateways, issuers, joint issuers/acquirers, and acquiring institutions, who jointly form the group defined as service providers to adopt 'strong authentication' by 1 February 2015. These requirements are for remote (online, mobile and the Internet) credit card transactions including and extending to e-mandates, mobile wallet, stored value cards, and credit transfers.

Guosen Securities (HK) 29

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 45 Illustration of Tokenisation process

7. 1234 5678 1234 5678 = 8888 Token Service Token Service 8888 8888 8888

1. I've got a card: 8888 8888 8888 8888 2. Here, use this instead 6. Is this valid? 8. Yes, all good. 10. This purchase has 1234 5678 1234 5678 1234 5678 1234 5678 Please proceed! been made using: Store it into SE. 8888 8888 8888 8888 POS

5. Can you process this? 1234 5678 1234 5678 3. User goes Merchant shopping at Acquirer Consumer Merchat Consumer Consumer Device Device Device

9. Yes, all good!

4. I am paying with: 1234 5678 1234 5678 Source: MobilePaymentTus, Guosen Securities (HK) Research

ECB defines strong authentication as「a procedure based on the use of two or more of the following elements categorised as knowledge, ownership and inherence: (i) something only the user knows, e.g. static password, code, personal identification number; (ii) something only the user possesses, e.g. token, smart card, mobile phone; (iii) something the user is, e.g. biometric characteristic, such as a fingerprint. In addition, the elements selected must be mutually independent, i.e. the breach of one does not compromise the other(s). At least one of the elements should be non-reusable and non-replicable (except for inherence), and not capable of being surreptitiously stolen via the Internet. The strong authentication procedure should be designed in such a way as to protect the confidentiality of the authentication data. 」

HCE NFC Infrastructure

HCE NFC is less secure than SE NFC requires the additional involvement of MNOs TSM and upgrades of users' SIM in the SE NFC phone, which has created a barrier for past NFC model's fast adoption. Given HCE NFC has no physical SE, it bypasses the previous TSM/SIM SE infrastructure on which MNOs like China Mobile, China Unicom are looking to apply their payment solutions.

Additional security Without the SE, HCE NFC needs additional measures to protect user credentials. For instance, measures required for HCE users PAN data is one of the major risks to HCE NFC, when issuers allow the same PAM value to be used across HCE NFC and other channels. Preventing unauthorized access in HCE depends on four pillars: limited use keys, tokens, device fingerprinting, and transaction risk analysis. Limited use keys expire preventing their misuse. Tokens reduce risk by replacing the PAN with fewer user data that passes seamlessly through the payment system. Device profiles (fingerprints) validate the phone. Data analysis provides real-time transaction assessment for identifying unusual activities.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Tokenisation is the process of substituting the card PAN with a single use or limited use "tokenised PAN". This reduces the impact of data breaches. If a "token" is compromised, it becomes no value. Tokenisation is a layer that can be applied on top of NFC payment. To employ this service, the issuer would call a token service provider (TSP) to generate tokens which would be delivered to the mobile app and used in payment transactions. When these transactions are processed through the network, the TSP would be called to convert tokens back into a PAN to allow the issuer to process the transaction in the normal way. SE NFC Infrastructure SE NFC has the added benefit that the fraud opportunity is limited to each device as there is only a small amount of data stored on them (single customer credentials and specific cryptographic information). This restricts the opportunity of any hacker to the value of device- only information. In other words, to get lots of fraud value the hacker must compromise many individual devices.

Apple Pay is based on SE Apple Pay tokenises user credentials including actual credit card number (PAN), CVV code, NFC technology name, expiry date and others into the iPhone SE. NXP designs and manufacturers Apple Pay's SE. The SE is embedded into the main controller board of the iPhone. This differs from some other forms of mobile payment devices whereby the SE was built into an SIM card, a removable component. This chip connects with an EMV-capable terminal and begins a dance of encrypted communication that would delight even the grumpiest of cryptographic nerds. Because of the increased security, EMV transactions made with chip cards can take longer than magnetic stripe card transaction. But leveraging on its proprietary technology, Apple Pay transactions are much faster but even more secure. By conforming to the latest specifications produced by EMVCo, Apple is in a favourable position in both China and the US, the two largest payment markets and having started to migrate from magnetic cards to EMV standard cards. Apple's Touch ID works with user's thumb to create a unique digital signature based on the user's fingerprint. Apple introduced Touch ID from of iPhone 5S. In the beginning, Apple used it in limited operations as a trigger to unlock the iPhone's screen, for example. But in fact, Touch ID is more secure than PIN, password, or swipe matrix because it created a card "almost" present transaction in authentication. "Almost" applies to in-app purchase because there is no POS terminal present during in-app purchase but the PassKit app verified users' presence through its fingerprint. The advent of this biometric authentication provides a seamless experience to consumers while reducing fraud risk from usual transaction done by keying in PIN, which should eventually lead to a lower fee structure for the merchants, in our view.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 46 App Integration for In-app Payment.

Source: Apple, Guosen Securities (HK) Research

We see magnetic card Samsung Pay works almost in the same way as Apple Pay as it adopts similar biometric acceptance as main security authentication. It has a separated SE that is embedded in the hardware while it does not concern for Samsung Pay control the end-to-end process but supports HCE NFC, leaving the issuers an option, unlike Apple Pay. We view Samsung Pay as less secure than Apple Pay due to its magnetic stripe compatibility. Though it would surely lead to wider adoption as it saves the additional capex needed for upgrading the POS, the transactions transmit user credentials to sales terminal directly, even though the transaction may be tokenised. This posts fraud risk to merchants and banks similar with conventional magnetic stripe card. Is NFC more secured than QR code?

Cloud-based QR code is less This is a big debate in the mobile payment industry. A general consensus from industry players secure than hard-ware we talked to, including banks, UnionPay, and vendors, is hardware-based solutions such as SE based NFC NFC is always more secure than cloud-based solutions such as HCE NFC and QR code. However, QR code has been widely used in different countries especially in emerging market under different payment model. For instance, US retailer-led consortium MCX also drives their mobile payment using QR code. QR Code is a modern 2-dimensional version of the 1-D barcode system for convenient information storing. It comprises of many 'square dots' to represent the data store in it. It was invented by Denso Wave in Japan in 1994 and used for tracking automotive parts back then. Depends on its different sizes from 21 x 21 to 177 x 177, it can hold more than 3kb (or 4,296 alpha-numeric chars) of data. Keying PIN is required for Alipay and Tenpay transactions, which create card almost present environment. A unique token is generated and sent to the merchant QR codes transmission.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

There are five types of QR code: Regular QR code, Micro QR code, iQR code, SQRC and Frame QR. Micro QR code is a smaller version of the QR. IQR code is an alternative to existing QR codes and can be created in square or rectangular formations. SQRC has a reading restriction function, which can be used to store private information or manage a company's internal information. Frame QR's canvas area can be used in marketing and promotion.

Figure 47 Higher Modules of QR Codes Have Higher Data Capability.

Source: Denso Wave, Guosen Securities (HK) Research

Figure 48 Major Type of QR code

Regular QR Micro QR iQR SQRC Frame QR The original QR Code, a code Up to 35 numerical High data capacity of 40,000 SQRC is a type of QR Code equipped The shape can be selected from a capable of coding 1,167 numerals it has only one position detection numerical. with reading restricting function. This template, or you can specify any with its maximum version being 14 pattern. This code allows a wide size range of can be used to store private shape and then change the center (73 x 73 modules) This configuration of Micro QR Code codes from ones smaller than the information and to manage company's location, size, and angle as necessary. allows printing in areas even smaller traditional QR Code and Micro QR internal information and the like. than QR Code Code to large ones that can store more data than these. Source: Denso Wave, Guosen Securities (HK) Research

Security concerns regarding QR code payment. There are two ways to generate QR codes: from the user's devices or a merchant's system. User-generated QR code: Although latest generators are able to generate a unique code for users' money account, if someone steals an image of a user's code instantly after it is generated, they can actually pay with that user's account. Fraudulent merchant-generated QR code: There could be malicious links embedded in the QR code that bring users to a fraudulent or malicious website. One past fraudulence case. An online shopper (victim) saw items she wants and ready to pay with her Alipay account. The web page displayed a QR code claiming it's some kind of red envelope. The unsuspected shopper scans the QR code which silently redirect her phone to download a piece of malware. The malware exploited the SMS password reset feature of the victim account and reset her password by forwarding the password reset SMS to the hacker mobile instead. As a result, the victim got her Alipay account stolen and she lost RMB39,000. The other example is when a consumer uses their smartphone to scan a QR code to download an application, and instead their phone receives a mass number of text messages from the unknown server, resulting in an inflated phone bill. QR codes are capable of containing any sort of data which can lead to a consumer downloading viruses, malware, or even spyware from websites

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

In March 2014, PBoC announced to suspend Tencent and Alipay's virtual credit cards and payments by scanning a barcode or QR code with sparking concern over its security, with offline payment. Nevertheless, the ban was soon lifted as we continue to see national banks added QR payment feature in their internet banking mobile app among others, and Tencent and Alibaba expanded their offline QR-code POS network since then. As Alipay and Tenpay require keying an additional PIN during the payment authentication, we believe QR code emulate a strong authentication and should be considered as "card almost present" scenario. Some news reported that Alibaba and Tencent both reached the agreement with PBoC's Technology unit on the potential security concerns over the QR code payment solutions and PBoC gave the green light on the implementation of it. We view regulatory risk as the biggest wild card for QR code payment is given its disruptive nature to existing four-party ecosystem led by UnionPay and Banks. But given the wide adoption now, there is no way to stop its growth in the near term.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

China’s Mobile Payment Future

Summary. We expect China’s Tier1/2 cities and Tier3 and below cities to follow to distinct development path in mobile payment. We anticipate higher NFC adoption in well-developed Tier 1/2 cities where card penetration is higher while Tier 3 and below cities could jump directly from cash to mobile wallets, skipping card phase. Implications for stakeholders can be mixed depending on their roles in the evolving ecosystem.

Future Development Path

China already led global China tops global digital payment with the highest adoption rate globally, based on Nielsen's ePayment survey of 13,000 respondents in 26 countries. 98% of Chinese respondents confirmed they paid for online purchases during the past 6 months, versus a global average of just 43%. IDC predicts worldwide mobile payment transaction to reach USD1trn in 2017, up 124% from the less than USD0.5trn in 2015. We think China will continue to lead the global mobile payment development driven by continued growth in mobile commerce and fast transition of consumer behavior from cash to mobile fronts. A lot of past discussion centers on US or Europe's payment adoption, yet we do not think China would resemble US or Europe's path. Given high population density, the large wealth gap between coastal regions and inner provinces, and sophisticated eCommerce development, we believe China is likely to build its own mobilisation path in payment.

We believe Tier1/2 cities We believe Tier1/2 cities and Tier 3 and below cities may follow two different paths of and Tier 3 and below will adoption. This is due to their difference in existing infrastructure, consumer behaviour as well follow distinct paths of mobile payment adoption as per capita income. Tier 1/2 cities benefit from their well-established banking infrastructure and higher card adoption compared to tier 3 and below. China's outstanding banking card reached 5.4bn as of Dec 2015. On a per capita basis, card penetration of about 3.6 debit cards and 0.3 credit cards penetration is still way behind global average. Most of those credit and debit cards issued are to residents in Tier 1/2 cities. Plus well-built POS network, security risk awareness, and strong banking system, we believe NFC-based mobile payment can take substantial market share from Alipay and Tenpay in the offline market. Tier 3 and lower cities embrace mobile technology. Lower-tier cities and rural areas were the key battlefields of China eCommerce industry in the past few years. Note that those regions had over 60% of total smartphone users in China, according to Umeng. Given low card penetration - we expect credit card penetration can be as low as 0.1 cards for some rural areas - payment migration could go straight from cash to mobile payment, skipping the card phase. We expect solutions from Internet giants such as Alipay and Tenpay to dominate, as people only need to link their mobile wallet with their existing bank saving account. Proximity payment solution can be difficult for them to reach given POS machine can be expensive to deploy.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 49 Card Penetration in China Figure 50 Mobile Payment Development Path For Asian Markets (Card/capita) High Senario 1 Asian markets with low card usage forego investment in traditional POS 8 infrastructure for cards and instead embraace mobile payments via wallets and stored value accounts. 7 HK Singapore 6 AUS&NZ Korea 5 Malaysia

Taiwan 4 China

penetration (%) penetration Senario 2 Thailand With high card usage, mobile payment is a 3 driver for markets to follow NFC-based payment. 2 India Vietnam 1 Smartphone Philipines Indonesia 0 Overall Debit card Credit card Tier 1/2 Tier 3 & below Low Credit/debit card annual spending (USD) High Source: PBoC, Guosen Securities (HK) Research Source: IDC, Guosen Securities (HK) Research

Advantaged and Disadvantaged Players in the Evolving Landscape With NFC joining the game, the competition of mobile payment will be fiercer than ever. Our key assumptions for future mobile landscape is NFC-based payment (QuickPass, Apple Pay, and Samsung Pay) would become one of the mainstreams and take market share from Alipay and Tenpay. This scenario is based on our view that NFC is likely to report fast adoption among tier1/ 2 cities in China in the coming few years.

UnionPay leads NFC-based UnionPay. We believe UnionPay is facing investment upcycle in the next few years as it starts payment to invest on mobile payment expansion including increasing investment in POS machine upgrades, merchants and consumer promotions to gain merchant adoption. As a latecomer in mobile payment, and considering the less value-added services UnionPay can provide to merchants versus Alipay and Tenpay, we expect UnionPay having no choice but to offer more discounts to merchants and promotions to consumers to boost adoption. The acceleration of NFC-based payment could lower fraud costs for card payment, in our view. With PBoC's mandate on chip-based card migration, we think this should give banks and PBoC high incentives to boost NFC payment.

Merchants will be benefited Merchants are ultimate beneficiaries to the offline mobile payment battle, in our view. They position neutral in NFC-based expansion as to them, mobile devices tap-and-go are similar with the card payment. We expect promotions from UnionPay when it expands mobile payment POS. Some of the small/medium merchants will benefit from the data analytics provided by Alipay and Tenpay, which could continue to benefit from the targeted information.

We favor POS vendors POS vendors should also benefit from the NFC adoption. We foresee aggressive investments from UnionPay on upgrading its POS network to be NFC compatible. The one-time upgrade can be done together with the ongoing PBoC 3.0 migration towards chip-based card so that future payment landscape can be EMV compatible. The upgrade cycle should be positive for shipments for POS vendors such as PAX Global. However, due to a high degree of competition from domestic players, we expect ASPs to be in a downtrend, meaning revenue growth in POS vendors to only be mild.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

We are less positive on Card vendors will be the most challenged as the mass population in China enters the mobile cards Internet space and consumers’ spending habits are shifting from cash to mobile. Though there would still be some card replacement and upgrades in between, we expect new banking card growth to moderate in 2016-18 because a. Tier1/2 cities' already high card penetration; b. card penetration in Tier 3 and below cities would remain low as users could jump directly from cash to mobile payment; and c. The P2P Internet financing has provided enough consumer credit to address the potential market of credit cards, in our view.

MNOs are most challenged MNOs. Following Apple Pay, Samsung Pay, and UnionPay's deployment, we believe MNO's position as mobile payment solution providers are most challenged, as simplified deployment model cuts MNOs out of the payment ecosystem. With aggressive investment plans from UnionPay and future penetration growth of NFC payment, we expect MNO's payment solutions to lose traction in the coming few years.

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China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Appendix A: Major Mobile Payment Solutions in China

Figure 51 Major Mobile Payment Solutions in China Solutions Platform Technology User experience Relevant Statistics/Facts

Apple Pay In-store (NFC, Apple Hardware based-SE Tap+Touch ID - iOS: 35% of total active device in 3Q15 (Umeng) 6/6S, Apple Watch) NFC - 3m activated cards after 2 days of launch

In-app purchase -15 banks support representing 80% of UnionPay cards to be with Apple Pay - 0.06% per transaction fee, half of what it charges in the US.

Samsung Pay In-store (NFC, Hardware based - Tap+Touch ID/PIN - 9 banks supports Samsung Pay Hardware/OS Solutions Hardware/OS Samsung Galaxy SE/MST NFC S6+, S6+ edge, Note 5+)

UnionPay Quick Pass In-store (NFC, Cloud based- HCE Tap+PIN -Android: 62% of total active device in 3Q15 smartphones with NFC (Umeng) Androd 4.4.2+) - Over 5.4bn card base and 20m POS base - 280 issuer banks support -260m online+mobile users

- 3m+ merchants Network Solutions Network

Alipay In-browser Cloud based- QR Scan+PIN - 400m user base, 270m+ active In-app code - 460k+ merchants, 200k offline merchants, In-store (QR) 500k+ taxis - Rmb3trn+ annual transaction volume

TenPay In-browser Cloud based- QR Scan+PIN - 300m+ user In-app code - 200k+ merchants

Third Party Solutions Party Third In-store (QR) - 400k+ enterprise clients

ICBC Cloud Payment In-store (QR) Cloud based- HCE Tap+PIN - >100m annual credit card issuance NFC - 5m issuance in the first batch

Bocom Maidanba In-app Cloud based- HCE Tap+PIN n.a.

Issuer Solutions Issuer NFC + QR code

China Mobile - In-store Hardware based - Tap+PIN - 100m registered user (2012) CMPay In-app SIM NFC - Rmb100bn transaction volume (2015)

China Unicom Best In-store Hardware based - Tap+PIN - 200m+ users

MNO Solutions MNO Pay SIM NFC - 200k merchants

Source: Guosen Securities (HK) Research

Guosen Securities (HK) 38

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Appendix B: Mobile Payment Deployment Models

Figure 52 Apple Pay Deployment Model

Apple UnionPay

Secure Token Service Element Provider

Apple Pay Issuer UnionPay Acquirer Service

Apple Pay Customer Merchant Wallet

Device OS Device Provider POS Vender Provoder

Source: Hyperion, Guosen Securities (HK) Research

Figure 53 Samsung Pay Deployment Model

Samsung UnionPay

Secure Token Service Element Provider

Samsung Issuer UnionPay Acquirer Pay Service

Samsung Customer Merchant Pay Wallet

Device OS Device Provider POS Vender Provoder

Source: Hyperion, Guosen Securities (HK) Research

Guosen Securities (HK) 39

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 54 UnionPay QuickPass Deployment Model

Issuer

Credential Account, ID&V & Management Authorisation

Issuer App Issuer UnionPay Acquirer

UnionPay

App Store Customer Merchant

Device OS Device Provider POS Vender Provoder

Source: Hyperion, Guosen Securities (HK) Research

Figure 55 MNO’s Mobile Payment Deployment Model

MNOs UnionPay

Secure Token Service Element Provider Provider

Wallet Issuer UnionPay Acquirer Provider

Device Customer Merchant Provider

Device OS POS Vender Provider

Source: Hyperion, Guosen Securities (HK) Research

Guosen Securities (HK) 40

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Appendix C: Global Smartphone Shipment

Figure 56 Global Smartphone Shipment Shipment (m) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2013 2014 2015

Samsung 89 75 80 75 82 73 84 82 82 316 318 321 Apple 44 35 39 74 61 48 48 75 51 153 193 232 Huawei 14 20 16 24 17 30 27 33 28 49 74 107 OPPO 5 6 9 9 7 9 11 14 19 12 30 43 Vivo N/A N/A N/A N/A 6 N/A N/A N/A 14 N/A N/A N/A Lenovo + Motorola 19 24 25 23 19 16 19 20 N/A 63 91 74 Xiaomi 11 16 17 17 15 19 19 18 14 19 61 71 LG 12 15 17 16 15 14 15 15 14 48 59 60 ZTE 9 10 11 12 10 13 13 14 N/A 36 43 51 Alcatel / TCL 6 9 11 16 9 10 13 11 12 18 41 42 Microsoft (Nokia) 8 10 11 11 9 8 6 5 N/A 31 40 28 Other brands 72 82 95 101 83 101 101 112 88 274 351 404 Total 288 302 332 377 334 341 355 400 335 1,018 1,300 1,431

Market Share (%) 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2013 2014 2015 Samsung 30.7% 24.8% 24.0% 19.9% 24.6% 21.4% 23.6% 20.5% 24.5% 31.1% 24.5% 22.4% Apple 15.2% 11.7% 11.8% 19.7% 18.3% 13.9% 13.5% 18.7% 15.3% 15.1% 14.8% 16.2% Huawei 4.7% 6.7% 5.0% 6.3% 5.2% 8.7% 7.7% 8.2% 8.2% 4.8% 5.7% 7.5% OPPO 1.7% 2.0% 2.8% 2.5% 2.2% 2.8% 3.2% 3.6% 5.5% 1.1% 2.3% 3.0% Vivo N/A N/A N/A N/A 1.9% N/A N/A N/A 4.3% N/A N/A N/A Lenovo + Motorola 6.6% 8.1% 7.5% 6.0% 5.6% 4.7% 5.3% 5.1% N/A 6.2% 7.0% 5.2% Xiaomi 3.8% 5.3% 5.2% 4.4% 4.4% 5.6% 5.3% 4.6% 4.2% 1.8% 4.7% 5.0% LG 4.3% 4.8% 5.1% 4.1% 4.6% 4.1% 4.2% 3.8% 4.1% 4.7% 4.6% 4.2% ZTE 3.1% 3.4% 3.5% 3.2% 3.1% 3.9% 3.6% 3.6% N/A 3.6% 3.3% 3.6% Alcatel / TCL 2.2% 2.9% 3.3% 4.1% 2.6% 2.8% 3.5% 2.7% 3.6% 1.7% 3.2% 2.9% Microsoft (Nokia) 2.8% 3.3% 3.3% 2.9% 2.6% 2.5% 1.6% 1.1% N/A 3.0% 3.1% 1.9% Other brands 25.1% 27.1% 28.6% 26.9% 24.9% 29.6% 28.4% 28.1% 26.2% 27.0% 27.0% 28.2% Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Source: IDC, Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 41

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Notes

Guosen Securities (HK) 42

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Notes

Guosen Securities (HK) 43

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Notes

Guosen Securities (HK) 44

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Notes

Guosen Securities (HK) 45

China / TMT Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Company Page

Guosen Securities (HK) 46

Company Research Transferring Coverage

Hong Kong TMT Pax Global (327 HK) Technology Going Global 12 May 2016 BUY We transfer coverage of PAX to Christopher Tse. We keep BUY with a Target price ▼ HKD9.10 new DCF-derived target price of HKD9.1 (36% upside), which implies 16x FY16F P/E. We forecast revenue and core earnings to grow Last price (11 May 16) HKD6.21 14%/17% CAGR in FY16-18F. Drivers in FY16 will continue to be EMV Upside/downside (%) 46.5 migration in the US, while China and Brazil enter a slower growth HSI 20055.29 Mkt cap (HKDm/USDm) 6,934/893 phase. We also build in a 12% payment services income mix by FY20 52 week range (HKD) 6.10 - 14.20 (conservative given peers’ 30-35% in FY15) and see upside from a Avg trading volume daily (USDm) 8.22 Free float (%) 59.1% faster-than-expected ramp up. Source: Bloomberg

A truly global player Performance PAX emerged from being a mostly domestic Chinese player to global top 3 with HKD ~10% market share. After achieving 21% YoY revenue and 41% YoY core net profit 120% growth in FY15, PAX posted a milder 13% YoY revenue growth in 1Q16 with strong 13.00 110% sales coming from overseas, which drove overseas sales mix to 57% (FY15: 49%). 11.00 100% Entering a more moderate growth phase 9.00 We forecast 14% revenue CAGR in FY16-18F, below the 30% growth spurt over the 90% past 3 years. Outlook for key markets: (1) In North America, we estimate EMV POS 7.00 80% to reach 57% of conventional POS installed base by FY18F (2015: 27%), largely 5.00 70% driven by EMV migration in the US. With only 2 major competitors in the market, May-15 Jan-16 we expect PAX will be able to increase its market share in North America to 15% Price(LHS) Rel. to HSI(RHS) (FY15: 5%), driving 63% revenue CAGR in FY16-18F with FY16F surging 128% YoY.

(2) We expect sales in LACIS to contract 5% CAGR in FY16-18F after strong growth in past years due to Brazil’s weak exchanges rate (vs USD), while competitors’ entry into Brazil’s mPOS market will likely dilute PAX’s >90% market share. (3) In Performance 1M 3M 12M China, we forecast 6% revenue CAGR over FY16-18F as ASP pressure from strong Absolute (%) (17.5) (14.9) (48.6) Absolute (USD, %) (17.6) (14.6) (48.7) competition will likely chip away the otherwise decent shipment growth. Other Relative to HSI (%) (15.6) (23.1) (21.0) emerging markets with growing middle class populations such as Indonesia, India Source: Bloomberg and Nigeria still offer growth potential as POS adoption rates are still very low. Further upside from payment services ramp up We project PAX’s service revenues to reach 12% of total by FY20F (FY15: 2%), which is conservative given Ingenico’s (ING FP, NR) / Verifone’s (PAY US, NR) Company background PAX Global is an electronic fund transfer point-of-sale (EFT- 30%/35% in FY15 and targets to reach 40%/45% by FY20. A stronger than expected POS) terminal solutions provider. The Company principally ramp up of PAX’s payment services will present upside to our target price. engaged in the development and sale of EFT-POS products and provision of related services. PAX develop and sells countertop DCF-derived target price of HKD9.1 implies 16x FY16F P/E; BUY and mobile EFT-POS terminals which are able to process a We forecast 17% core profit CAGR in FY16-18F. We switch to a DCF valuation (9.0% wide range of electronic payment types. Source: Bloomberg cost of equity & 2% terminal growth). Our target price implies 15.9x FY16F P/E, not demanding given industry leaders’ 17-18x average, PAX’s increasing market share and solid financial position. Investment risks: keen competition in the China, prolonged economic downturn in Brazil, execution risk on payment services.

Figure 1: Financial Summary Christopher Tse Year to Dec 31 (HKDm) FY14A FY15A FY16F FY17F FY18F SFC CE No.: BAZ779 Revenue 2,373 2,871 3,285 3,750 4,271 +852 2899 6768 Operating Profit 463 658 752 866 1,017 [email protected]

Reported Profit 392 620 647 744 875 Jackson Yu, CFA Underlying Profit 392 551 647 744 875 SFC CE No.: AUX358 Underlying EPS (HKD) 0.353 0.490 0.575 0.661 0.777 +852 2899 6773 DPS (HKD) 0.0 0.04 0.0 0.0 0.0 [email protected]

BVPS (HKD) 2.29 2.73 3.29 3.95 4.73 Zhenghao Jiang P/E (x) 17.6 12.7 10.8 9.4 8.0 SFC CE No.: BGL257 Dividend Yield (%) 0.0 0.6 0.0 0.0 0.0 +852 2899 6774 P/B (x) 2.7 2.3 1.9 1.6 1.3 [email protected]

Source: Company Data, Guosen Securities (HK) Research

公司报告转让覆盖

百富环球 (327 HK) 香港科技/通信技术迈向全球 2016 年 5 月 12 日买入我们转让覆盖予谢嘉熙，维持买入评级，现金流折现模型（DCF）估算目标价 9.1 港元（36%上涨空间），隐含 16 倍 16 财年市盈率。目标价 ▼ HKD9.10 我们预计 16 至 18 财年营收与核心盈利按 14%/17%复合增长。美国 EMV 迁移将带动公司 16 财年表现，而中国与巴西已步入增长放缓收盘价 (11 May 16) HKD6.21 阶段。我们预计 20 财年支付服务业务营收贡献比例达到 12%（较 Upside/downside (%) 46.5 恒生指数 20055.29

同业 15 财年的 30-35%相对保守）且超预期增长将提升上涨空间。总市值 (HKDm/USDm) 6,934/893

52 周最高/最低 (HKD) 6.10 - 14.20 日均成交额真正的全球性企业 (USDm) 8.22 流通量 (%) 59.1% 百富的业务曾几乎集中于国内，而现如今成长为全球第三大供应商，占据资料来源: 彭博全球 10%的市场份额。公司 15 财年营收与核心净利润分别同比增长 21%与 41%，而后受海外的强劲销售推动，公司 16 财年 1 季度营收同比增长稍缓股价表现至 13%，海外营收贡献比例提升至 57%（15 财年：49%）。 HKD

进入更为平缓增长的阶段 120% 13.00 我们预测 16 至 18 财年的营收年复合增长率为 14%，低于过去 3 年井喷式 110% 的 30%。主要市场前瞻：（1）在北美，我们预期受美国 EMV 迁移的推动， 11.00 100% 18 财年 EMV POS 数量将占传统 POS 总安装数的 57%（2015：27%）。鉴于 9.00 90% 在该市场仅有 2 个主要竞争对手，我们预期百富市占率将增长至 15%（15 7.00 80% 财年 5%），推动 16 至 18 财年营收按 63%增长，且 16 财年营收将同比飙 5.00 70% 升 128%。（2）尽管拉美与独联体地区过去几年销售表现强劲，我们预期 May-15 Jan-16 布雷尔兑美元外汇的走弱以及竞争对手进入巴西移动 POS 市场将稀释百富 Price(LHS) Rel. to HSI(RHS) 份额（目前>90%），导致该地区 16 至 18 财年销售按 5%年复合收缩。（3）在中国，尽管出货量表现不错，但激烈竞争下单位产品价格承压，我们预

测 16 至 18 财年营收按 6%年复合增长。其他中产阶级人群不断壮大的新股票数据 1M 3M 12M 兴市场，如印尼、印度和尼日利亚 POS 覆盖率仍较低，将带来增长潜力。绝对回报 (%) (17.5) (14.9) (48.6) 绝对回报 (USD, %) (17.6) (14.6) (48.7) 支付服务提升上涨空间相对 HSI 回报 (%) (15.6) (23.1) (21.0) 我们预期百富的支付服务业务至 20 财年将贡献总营收的 12%（15 财年：资料来源: 彭博

2%），较 Ingenico（ING FP，未评级）/VeriFone(PAY US,未评级)15 财

年的 30%/35%与 20 财年分目标的 40%/45%而言相对保守。其支付服务业务公司簡介超预期的攀升有望给我们的目标价提供上涨空间。百富环球是一家电子支付(EFT-POS)终端机解决方案供货商。该公司主要从事开发及销售 EFT-POS 产品并提供相关 DCF 估算目标价 9.1 港元隐含 16 倍 16 财年市盈率；买入服务。百富研制和销售能够处理多种类型电子支付范围的我们预测 16 至 18 财年核心盈利按 17%复合增长。我们转换至 DCF 估值台面和移动电子支付终端机。（9.0%股本成本率 2%终端增长率）。考虑到较业龙头的 17-18x 倍的市盈资料来源: 彭博率均值，百富逐步扩大的市场份额以及稳健的财务状况，我们目标价隐含的 16 倍 16 财年市盈率不算激进。投资风险：国内市场的激烈竞争，巴西

经济的长期低迷，支付服务业务的执行风险。

Figure 2: 盈利预测截至 Dec 31 (港元百万) FY14A FY15A FY16F FY17F FY18F 谢嘉熙证监会中央编号:BAZ779 营业额 2,373 2,871 3,285 3,750 4,271 +852 2899 6768 经营盈利 463 658 752 866 1,017 [email protected] 净利润 392 620 647 744 875 实际盈利 392 551 647 744 875 俞励颉, CFA 证监会中央编号: AUX358 每股实际盈利 (HKD) 0.353 0.490 0.575 0.661 0.777 +852 2899 6773 每股股息 (HKD) 0.0 0.04 0.0 0.0 0.0 [email protected] 每股账面价值 (HKD) 2.29 2.73 3.29 3.95 4.73 姜正浩市盈率 (x) 17.6 12.7 10.8 9.4 8.0 证监会中央编号: 股息率 0.0 0.6 0.0 0.0 0.0 (%) +852 2899 6774 市净率 (x) 2.7 2.3 1.9 1.6 1.3 [email protected]

资料来源：国信证券 (香港) 研究部

Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Investment Highlights PAX Global shipped more than US market is still the growth engine. In North America, we estimate EMV POS to reach 57% 4 million POS terminals in of conventional POS installed base by FY18F (2015: 27%), largely driven by EMV migration in FY15, ranking third globally the US. With only 2 major competitors, we expect PAX will be able to increase its market Figure 3 PAX Global Shipment share in North America to 15% (FY15: 5%), driving 63% revenue CAGR in FY16-18F with FY16F Estimates surging 128% YoY. In 2015, It obtained EMV certifications with First Data, the largest payment (m) gateway in the US and entered into a cooperation to help Heartland (HPY US, NR) migrate its 5.9 merchants to EMV. According to The Nilson Report, Heartland was the 5th largest payment 5.2 4.6 processor in the US with 5% transaction share in 2015. Its customer base consists of 300,000 4.0 merchants, providing a solid addressable market for PAX. 3.0 2.1 Emerging markets still offer plenty of growth potential. Emerging markets such as Indonesia, 1.3 India and Nigeria are nations with substantial middle class populations. These markets have only begun to adopt electronic payment methods with low POS adoption rates and should provide plenty of growth potential in the long run.

FY12 FY13 FY14 FY15

FY17F FY18F FY16F Further upside from payment services ramp up. PAX aims to capture a higher share in the Source: Company Data, Guosen Securities payment value chain. To build up its presence in this area, PAX increased R&D headcount by (HK) Research 21% and acquired Kashuo (for its big data) and Ieazy (for its ERP solutions for catering services) Figure 4 PAX US Sales Growth in FY15. We project service payment to account for 12% of PAX’s total revenue by FY2020, Estimates still conservative considering services income already account for 30/35% of Ingenico’s / (%) Verifone’s FY15 total revenues. 60

50 Brazil and China catching a breather. We expect sales in LACIS to contract 5% CAGR in FY16- 18F after strong growth in past years, as part of the Brazil Real’s (BRL) 24% depreciation vs 40 USD since 2015 will likely be passed on to PAX. Both Ingenico and Verifone are also launching 30 mPOS products in Brazil, which we think will likely dilute PAX’s >90% market share. The weak 20 economy in Brazil should have limited impact on mPOS shipments as merchants would be more inclined to choose cheaper mPOS over conventional POS, in our view. 10

0 In China, UnionPay launched Cloud-based Quick Pass in Dec-2015 that enables a wide

selection of NFC-enabled smartphones to make online/offline payments via POS terminals.

FY14 FY15 FY13

FY17F FY18F FY16F NFC-capable POS terminals currently make up ~35% of China’s POS installed base, while NFC- Source: Company Data, Guosen Securities (HK) Research enabled handsets account for 70% of total smartphone installed base according to market estimates. We believe UnionPay’s strategy is to accelerate the deployment of NFC mobile Figure 5 China & Brazil Sales payment ecosystem across China in order to defend its market share against Alipay and Growth Expected to Slow Tenpay, which should be positive for POS terminal shipment. For PAX’s China sales, we (%) forecast 6% YoY revenue CAGR in FY16-18F coming from ~11-14% YoY shipment growth vs 1000 ASP declines due to keen competition in the Chinese market. LACIS 800 Maintain BUY with DCF target price of HKD9.1. We forecast 17% core profit CAGR in FY16- 600 18F. We switch to a DCF valuation model based on 9.0% cost of equity and 2.0% terminal growth. We believe DCF better reflects the long-term trends of increasing POS adoption in 400 various key markets and the ramp up of service income. Our target price implies 16x FY16F 200 P/E which is in line with the company’s mean forward P/E and still lower than China Ingenico’s/Verifone’s 21x/16x mean forward P/E. PAX is also in a strong net cash position

0 compared to peers’ average 40% net gearing ratio. FY15

-200 FY14

FY16F FY17F FY18F

Source: Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 49

Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Focus Charts

Figure 6 We expect market share continues to rise Figure 7 Forecasting 14% revenue CAGR in FY16-18F… (m) (%) (HKDm) 50 14 4,500 203 45 4,000 12 FY16-18F CAGR: 14% 109 40 3,500 10 74 35 3,000 50 2,327 30 8 2,500 2,032 1,685 25 48 2,000 1,341 20 6 987 1,500 15 4 426 1,000 394 10 1,526 1,609 1,741 2 1,338 1,480 5 500 893 1,005 0 0 0 FY12 FY13 FY14 FY15 FY16F FY17F FY18F FY12 FY13 FY14 FY15 FY16F FY17F FY18F Global Shipment PAX Shipment PAX Market Share China hardware sales Overseas hardware sales Services & accessories Source: Guosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

Figure 8 … with overseas sales overtaking China in FY16 Figure 9We forecast service income to rise to 12% of PAX’s revenue by 2020, still way behind ING FP and PAY US’s FY15 level (%) Service income as % of revenue Verifone 100 45% 45% 90 28 27 40% 80 33% 40% 31 35% 70 Ingenico 29 31 60 31 31 30% 30% 50 25% 40 69 70 20% 30 58 52 50 47 15% 20 45 12% 10 10% 0 5% PAX Global FY12 FY13 FY14 FY15 FY16F FY17F FY18F 2% China Rest of world LACIS North America 0% FY15 FY20F Source: Nilson, Company Data, Guosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

Figure 10 Revenue and earnings growth entering a slower growth period Figure 11 Payment terminal P/E relative to EPS growth

(%) 2016 P/E 80 70.0

70 60.0 Xinguodu 60 50.0 50 40.0 40 30.0 30 20.0 ING FP 20 PAY US PAX 10 10.0

0 0.0 FY12 FY13 FY14 FY15 FY16F FY17F FY18F 10.0 15.0 20.0 25.0 30.0 35.0 3 year EPS CAGR (%) Revenue growth Underlying Net Profit Growth Source: Company Data, Guosen Securities (HK) Research Source: Bloomberg, Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 50

Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

What’s Changed?

We have a lower revenue Coverage has been transferred to Christopher Tse. We now have a less bullish revenue forecast for FY16/17F forecast in FY16/17F after taking into account the installed base and replacement cycles of conventional POS in key markets. We also assume a lower operating cost ratio. Finally, we

switched to a DCF valuation model, which better reflects the long-term POS adoption trends in key markets and the ramp up of service income.

Figure 12 Changes vs Previous Coverage

FY16 FY17

(HKDm) Old New Chg Old New Chg

China sales 1,871 1,526 (18.5%) 2,215 1,609 (27.4%)

Overseas sales 1,858 1,685 (9.3%) 2,415 2,032 (15.8%)

Total sales 3,729 3,211 (13.9%) 4,629 3,641 (21.4%) Revenue growth 25.9% 14.4% 24.2% 14.2%

Gross margin 38.0% 38.8% 38.0% 38.5%

Operating profit 763 752 (1.4%) 943 866 (8.2%)

Opex / sales (20.0%) (19.2%) (20.0%) (18.8%)

Net profit 649 647 (0.3%) 802 744 (7.2%) Source: Company Data, Guosen Securities (HK) Research

Earnings Drivers

US Market Still The Growth Engine

Penetration rate of EMV is In North America, we estimate EMV POS to reach 57% of conventional POS installed base by expected to increase in the FY18F (2015: 27%), largely driven by EMV migration in the US. With only 2 major competitors US due to liability shift in the market, we expect PAX will be able to increase its market share in North America to 15% (FY15: 5%), driving 63% revenue CAGR in FY16-18F with FY16F surging 128% YoY.

Figure 13 North America Revenue Key Assumptions North America assumptions (shipment and installed base in million) 2012 2013 2014 2015 2016F 2017F 2018F End of year POS installed base 13 13 13 15 16 17 17 EMV penetration rate 6% 9% 17% 27% 40% 51% 60%

North America POS shipment 2 2 2 3 3 3 3 PAX market share 1% 2% 3% 5% 10% 13% 15% PAX shipment 0.0 0.0 0.1 0.1 0.3 0.4 0.5 ASP (HKD) 592 694 773 820 923 1,015 1,015 North America devices revenue (HKDm) 18 26 53 105 241 377 458 YoY 388% 47% 107% 98% 128% 56% 21% Source: Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 51

Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

FY15 was a breakthrough year for PAX’s US business. It obtained EMV certifications with First Data, the largest payment gateway in the US and entered into a cooperation to help Heartland (HPY US, NR) migrate its merchants to EMV. According to The Nilson Report, Heartland was the 5th largest payment processor in the US with 5% transaction share in 2015. Its customer base consists of 300,000 merchants, providing a solid addressable market for PAX.

Figure 14 Top Acquirers in the US (2015) Top Acquirers in the US (2015) USDbn % First Data 18.6 20% Vantiv 17.7 19% Chase 15.0 16% BofA 14.4 16% Heartland 4.3 5% Worldpay 3.7 4% Wells 3.4 4% Elavon 3.4 4% Global 2.7 3% Others 9.4 10% Total 92.4 100%

Source: Nilson, Guosen Securities (HK) Research

Figure 15 PAX’s flagship PX7 offers competitive hardware features and certification standards compared to peers

Brand PAX Ingenico Verifone Model PX7 iSC Touch 480 MX925 Hardware specification ARM-11, 400MHz ARM9, 450MHz ARM-11, 400MHz 7 inch TFT LCD 7 inch WVGA 7 inch WVGA 800x480 pixels 800x480 pixels 800x480 pixels 512MB ram 256MB ram 512MB ram Certifications Magnetic card reader Magnetic card reader Magnetic card reader EMV EMV EMV

Source: Company Data, Guosen Securities (HK) Research

Emerging Markets Still Offer Large Growth Potential

Emerging markets such as Indonesia, India and Nigeria are nations with substantial middle ATM per capita of developing countries is class populations and rising GDP per capital. These markets have only begun to adopt still largely behind electronic payment methods with low POS adoption rates and should provide plenty of developed nations growth potential in the long run. According to World Bank data, automatic teller machine (ATM) per 100,000 adults (which we believe to be a proxy to POS terminal penetration rate) reached 43 in China, 42 in Indonesia, 23 in the Philippines and 13 in Nigeria and India, lagging developed markets such as Japan’s 128 and Australia’s 164. PAX has disclosed its revenues by region for the first time in 1Q16, which shows (1) 68% YoY rise in APAC revenue due to ramp up of mPOS shipment in India. (2) 30% YoY increase in Europe, Middle East and Africa revenues largely due to acquisition of PAX’s distributor in Italy last year, but also ramp up of sales in Middle east.

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

LACIS Revenue Slowing Down After Years of Explosive Growth

Impact of BRL depreciation We expect revenue from LACIS to drop 5% CAGR in FY16-18F. We forecast lower market vs USD should partly pass share as competitors’ entry into the Brazil’s mPOS market will likely dilute PAX’s >90% market on to POS suppliers in the share. We also believe ASP will see pressure as customers would require price adjustments in form of lower ASP response to the 24% depreciation in BRL/USD exchange rate since 2015 (PAX deals with Brazil customers in USD). We argue Brazil’s weak economy should have limited impact on mPOS

shipment and adoption rates as merchants would be more inclined to choose cheaper mPOS over conventional POS.

Figure 16 LACIS market key assumptions LACIS assumptions

(shipment in millions) 2012 2013 2014 2015 2016F 2017F 2018F

Brazil mPOS market

Potential mPOS merchants 8.4 8.5 8.5 8.5 8.6 8.6 8.7 mPOS penetration rate -- -- 4% 13% 20% 27% 34%

Total mPOS shipment -- -- 0.4 0.8 0.9 1.0 1.2

PAX Brazil mPOS market share -- -- 100% 95% 80% 65% 55%

Unit shipment -- -- 0.35 0.77 0.71 0.68 0.66

ASP (HKD) -- -- 500 480 460 460 460 Brazil devices revenue (HKDm) -- -- 175 369 328 312 304

YoY ------111% -11% -5% -2%

Other LACIS countries 13 20 35 38 42 46 51

LACIS devices revenue (HKDm) 13 20 210 407 370 358 355

YoY 0% 58% 929% 94% -9% -3% -1%

Source: Company Data, Guosen Securities (HK) Research

Growth in China Slows on Strong Competition

UnionPay aims to build up UnionPay launched Cloud-based Quick Pass in Dec-2015 that enables a wide selection of NFC- its mobile payment ecosystem to keep its enabled smartphones to make online/offline payments via POS terminals. NFC-capable POS market share in payments terminals currently make up ~35% of China’s POS installed base, while NFC-enabled handsets vs Alipay and Tenpay account for 60% of total smartphone installed base according to market estimates. We believe UnionPay wishes to accelerate the deployment of NFC mobile payment ecosystem across China in order to retain market share against Alipay and Tenpay, which should be positive for POS terminal shipment. For PAX’s China sales, we forecast 6% YoY revenue CAGR in FY16-18F coming from ~11-14% YoY shipment growth vs ASP declines due to keen competition in the Chinese market.

Figure 17 Key assumptions of revenue from China

China assumptions (shipment in millions) 2012 2013 2014 2015 2016F 2017F 2018F End of year POS installed base 7 11 16 22 27 32 37 Total POS shipment 3.35 5.08 7.67 9.22 10.22 11.34 12.92 PAX market share 23% 30% 25% 24% 24% 24% 24% PAX shipment 0.77 1.54 1.90 2.21 2.45 2.72 3.10 ASP 1,158 653 703 669 622 591 562 China devices revenue (HKDm) 893 1005 1338 1480 1526 1609 1741 YoY 21% 13% 33% 11% 3% 5% 8% Source: Company Data, Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Long-term driver: Ramp up of payment services income PAX currently derives most of its revenues from POS terminal hardware sales (includes software customization), which is subject to 3-5 years replacement cycles (or shorter, if there are standard upgrades). Payment services are a growing area within the payment value chain. By offering these services, POS terminal vendors can (1) lower customer switch rate, (2) tap into transaction share, (3) better differentiate their products through unique one-stop solutions and (4) derive a recurring revenue stream. Payment services range from software design, implementation, maintenance, and payment processing. Further value added services include integration of front-end POS with backend enterprise resource planning (ERP) / customer relationship management (CRM), business intelligence and data analytics etc.

Figure 18 Payment Value Chain

POS terminal sales One off (3-5 yrs Hardware and software sales with customization lifecycle)

Hardware services

Monthly fee Leases, installation, maintenance, software development

Connectivity

Monthly fee Highly secured data connection

Payment processing & settlement

Revenue per transaction

Value added services ERP, Inventory CRM, loyalty Big data, Bill payment, Foreign currency management program analytics Prepaid top-up transactions

Source: Guosen Securities (HK) Research

In FY15, payment services consisted of 30% and 35% of Ingenico’s and Verifone’s revenues, respectively, while it only accounts for 2% of PAX’s FY15 revenue. Ingenico targets to expand this segment to 40% of its FY20 revenues, while Verifone sees 45% contribution to its US revenue by FY20. This highlights the potential and importance of payment services. To build up its presence in this area, PAX increased headcount by 21%, mostly in R&D. It also acquired start-up payment services companies in China: Kashuo (for spending big data) and Ieazy (for its ERP solutions for catering services) in FY15. We believe PAX aims to integrate those service solutions into its global product offering. We project PAX’s payment service revenues will reach 12% by 2020F, from currently just about 2%. We think our projection is on the conservative side as it is still much lower than industry leaders. A stronger than expected ramp up of PAX’s payment services will present upside to our target price.

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Peers read-across Ingenico (ING FP, NR) targets 9% CAGR in terminal and 19% CAGR in services sales Ingenico is the leader in the payment terminal sector with 40% market share in 2015. Based Service income accounts for 30% of Ingenico and 35% on Ingenico’s FY15 results, its POS terminal sales rose 22% YoY to EUR1.5b while its of Verifone’s FY15 revenues transactions services revenues jumped 91% YoY after the acquisition of GlobalCollect. Large

retail merchants and payment acquirers / acquiring banks accounted for 40/60% of its sales. In terms of margins, terminals gross margin was 47.5%, implying payment services margin was 35%.

Figure 19 Ingenico Revenue by Region, FY14 (left) and FY15 (right)

Others 10% Others

Latin 20% Eruope & America Africa 13% 35% Eruope & Latin Africa America North 45% 10% America 12% North APAC & APAC & America Middle Middle East 15% East 20% 20%

Source: Company Data, Guosen Securities (HK) Research

Ingenico targets to increase its revenues from EUR2.2b in FY15 to EUR4.0b in FY20, implying ~13% CAGR over the 5 year horizon. A major focus of Ingenico will be to enhance its payment services, with a target to increase services sales mix to 40% of revenue by 2020, from 30% in 2015.

Figure 20 Ingenico's focus will be on payment services Ingenico revenue and target (FY Dec 31, EURm) FY14 FY15 FY20 CAGR target

Terminals 1,259 1,532 2400 9% Payment services 349 665 1600 19% Total revenue 1,607 2,197 4,000 13%

Source: Company Data Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Verifone (PAY US, NR) also sees strong growth in payment services

Verifone’s overseas revenue Verifone had about 15-20% market share in 2015. Verifone reported 7% YoY revenue growth saw a substantial drop, in FY15 (Oct-end), largely driven by 50% YoY growth in the US vs 7-15% declines across all while US grew strongly on EMV migration other regions. It guides for 4-5% revenue growth in FY16 and holds a view that the payment devices market will grow at 7-8% pace over 2016-2020. This is slightly lower than that of Ingenico. Revenue mix in system solutions (i.e. POS terminal solutions) / services was 67%/33% in FY15. Gross margin of Verifone’s system solutions ranged from 37-40% in FY14/15.

Figure 21 Services account for ~35% of Verifone's FY15 revenue Figure 22 North America is Verifone's home turf

FY Oct 31 (USDm) FY14 FY15 % FY14 FY15 System solutions 1,167 1,310 North America 27% 42% Services 707 691 EMEA 35% 29% % LATAM 22% 17% System solutions 62% 65% Asia Pacific 17% 12% Services 38% 35% Total 100% 100%

Source: Company Data, Guosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

In the US market, Verifone reported that the ASP of its MX9 multilane solution (including services) was ~USD470 per terminal, which we have used for our forecast on PAX’s US revenues. It also expects services revenue to make up 45% of US revenues by 2020.

Figure 23 Top 3 POS Vendor Comparison Comparison of top 3 payment terminal vendors Ingenico Verifone PAX Global Dec-14 Dec-15 Oct-14 Oct-15 Dec-14 Dec-15 Revenue YoY Growth Hardware 20% 16% 9% 13% 62% 21% Services 13% 9% 12% -2% 18% 3% Overall 19% 14% 10% 7% 61% 21%

Gross margins Hardware 47% 48% 37% 41% 37% 38% Services 44% 35% 42% 42% 29% 28% Overall 44% 44% 39% 41% 36% 38%

Cost structure R&D / revenue 7% 7% 11% 10% 5% 5% Total opex / revenue 24% 24% 38% 36% 20% 19% EBIT margin 20% 20% 10% 12% 20% 23% EBITDA margin 23% 23% 14% 16% 20% 23% Net profit margin 11% 10% 9% 11% 17% 19%

Net debt (cash) / equity 110% 17% 58% 63% -75% -70%

Source: Company Data, Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Financial Forecasts Breakthrough in Overseas Sales in 1Q16 PAX reported a 13% YoY revenue growth in 1Q16, of which overseas sales rose 25% YoY vs China’s 7% growth (constant currency basis). This is the first time PAX has provided detailed breakdown on overseas sales location. For each market, (1) North America revenue surged 248% YoY due to the ongoing EMV migration. (2) Europe, Middle East and Africa rose 30% YoY largely thanks to acquisition of PAX’s distributor in Italy last year. (3) APAC revenue rose 68% YoY due to ramp up of mPOS shipment in India. (4) LACIS revenue dropped 32% YoY due to a shipment delay in Brazil, but we believe the weak economic environment and declining exchange rates also contributed to the decline.

Figure 24 Overseas Sales Showing Good Progress in 1Q16 HKDm 1Q15 1Q16 YoY YoY (constant currency)

China 285 289 1% 7% Overseas 308 384 25% 25% Europe, Middle East & Africa 157 205 30% -- LACIS 105 71 -32% -- APAC 30 50 68% -- North America 17 58 248% -- Total 593 672 13% N/A % of full year revenue 21% 20% --

Source: Company Data, Guosen Securities (HK) Research

Figure 25 Sales Mix Now More Spread Out Across Regions (%) 100% 3 5 9 90% 7 18 80% 11 70% 60% 26 30 50% 40% 30% 48 20% 43 10% 0% 1Q15 1Q16

China Europe, Middle East & Africa LACIS APAC North America

Source: Company Data, Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Top and Bottom Line Entering Milder Growth Phase We expect PAX to deliver 14% revenue growth in each year in FY16-18F. We believe the main growth driver will continue to be EMV migration in the US. Growth in China and Brazil will slow down while other emerging markets with a growing middle class such as Indonesia, India and Nigeria will still provide growth opportunities. We expect overseas sales to grow at 20% CAGR in FY16-18F vs China’s 8% CAGR. This will be positive to gross margins as overseas sales generally have high profitability than China (~48% gross margin vs China’s ~28%). We expect PAX will focus on R&D on service income and thus forecast R&D / revenue to climb towards 7% from 5.5% in FY15. Overall, we expect only slight scaling effect on operating expenses. Tax rates will revert to a normal 13-15% from FY15’s 6% (PAX booked a one-off tax overprovision in FY15). We forecast 17%/15%/18% core earnings growth in FY16-18F.

Figure 26 Key Assumptions Key assumptions FY14 FY15 FY16F FY17F FY18F Revenue (HKDm) China 1,338 1,480 1,526 1,609 1,741 LACIS 210 407 370 358 355 North America 53 105 241 377 458 Other regions 724 829 1,074 1,298 1,515 Total hardware sales 2,325 2,821 3,211 3,641 4,068 Services income 48 50 74 109 203 Total revenue 2,373 2,871 3,285 3,750 4,271 Service income % of revenue 2.1% 1.8% 2.3% 3.0% 5.0%

Shipment (m) China 1.9 2.2 2.5 2.7 3.1 LACIS 0.4 0.8 0.8 0.7 0.7 North America 0.1 0.1 0.3 0.4 0.5 Other regions 0.7 0.8 1.1 1.3 1.6 Total 3.0 4.0 4.6 5.2 5.9

ASP (HKD/unit) China 703 669 622 591 562 LACIS 531 498 481 482 484 North America 773 820 923 1015 1015 Other regions 1069 1017 997 977 957 Blended 764 710 704 705 693

Source: Nilson, Company Data, Guosen Securities (HK) Research

Figure 27 Gross Margins Expected to Hover Around 38%

Gross margin assumptions China 28.9% 28.5% 28.2% 27.5% 27.0% Overseas 47.0% 49.0% 48.8% 47.6% 47.0% Services 28.9% 28.5% 29.0% 30.0% 33.0% Blended 36.4% 38.1% 38.8% 38.5% 38.2%

Source: Company Data, Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 28 Profit and Loss Forecasts

FY Dec-31 (HKDm) FY14 FY15 FY16F FY17F FY18F Revenue 2,373 2,871 3,285 3,750 4,271 YoY 61% 21% 14% 14% 14% Cost of sales -1,508 -1,778 -1,990 -2,278 -2,584 Gross profit 865 1,092 1,295 1,473 1,688 GPM 36.4% 38.1% 38.8% 38.5% 38.2% Other income 70 109 87 97 109 Other gains 0 0 0 0 0 Selling & distribution -219 -236 -257 -277 -300 Admin expenses -254 -308 -372 -426 -480 Opex / revenue -19.9% -18.9% -19.2% -18.8% -18.2% EBIT 463 658 752 866 1,017 EBIT margin 19.5% 22.9% 22.9% 23.1% 23.8% Finance cost 0 0 0 0 0 PBT 463 658 752 866 1,017 Income tax -71 -38 -105 -121 -142 Tax rate % -15.4% -5.7% -14.0% -14.0% -14.0% Non-controlling interest 0 0 0 0 0

Net income to shareholders 392 621 647 744 875 Our core net income forecasts are 2-3% below Adjustments 0 69 0 0 0 consensus Net income (core) 392 551 647 744 875 YoY 73% 41% 17% 15% 18%

Source: Company Data, Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Valuation Maintain BUY with DCF-derived target price of HKD9.1 We forecast 17% core profit CAGR in FY16-18F. We switch to a DCF valuation model based on 9.0% cost of equity and 2.0% terminal growth. We believe DCF better reflects the long-term trends of increasing POS adoption in various key markets and the ramp up of service income. Our target price implies 16x FY16F P/E which is in line with the company’s mean forward P/E and still lower than Ingenico’s/Verifone’s 21x/16x mean forward P/E. PAX is also in a strong net cash position compared to peers’ average 40% net gearing ratio.

Figure 29 DCF Valuation

(HKDm) 2016F 2017F 2018F 2019F 2020F EBIT 752 866 1,017 1,212 1,405 Interest Income -24 -29 -35 -42 -50 EBIT Adjusted 729 837 983 1,170 1,355 Tax Rate -14% -14% -14% -14% -14% NOPAT 627 720 845 1,006 1,165 Depreciation & Amortization 6 7 8 9 10 Capex -7 -8 -9 -10 -11 Working Capital -155 -210 -248 -249 -243 Enterprise Cash Flow 471 509 597 756 921 Discounted Cash Flow 432 429 461 536 599

PV of Discreet Forecasts 2,456 Long-term Growth 2.0% PV from 2021 onwards 2,756 Cost of Equity 9.0% Terminal Value 2,941 Rf 3.0% Enterprise Value 8,154 Beta 1.2 + Net Cash 2,144 Risk Premium 5.0% + Investments 0 - Non-controlling Interests 13

Equity Value 10,285 Shares Outstanding 1,126 Fair value / share (rounded) 9.10 Implied FY16F P/E 15.9x

Source: Company Data, Guosen Securities (HK) Research

We believe 327 HK’s recent share price downtrend reflects investors’ growth expectations of China and Brazil markets, both of which have been disappointing. However, with the long term trend of increasing adoption in new emerging markets, we believe overseas markets will very likely be the main sales and earnings driver in the future. As PAX’s overseas sales mix increase, we believe the stock should re-rate closer to Ingenico’s and Verifone’s multiples in the long run.

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 30 Peer Valuation FY2 3-mth avg EPS 3-Yr EPS Hist Mkt cap t/o FY2 FY1 EPS YoY CAGR Div Yld FY1 Div Hist FY1 Company Ticker Price (USDm) (USDm) Hist P/E FY1 P/E P/E YoY (%) (%) (%) PEG (%) Yld (%) P/BV P/BV Pax Global 327 HK 6.21 893 8.2 11.0 10.8 9.4 17.4 15.0 16.6 0.9 0.6 0.0 2.3 1.9 Ingenico ING FP 102.20 7,126 34.0 26.8 21.6 18.8 24.1 14.9 17.8 1.2 1.3 1.4 4.1 3.6 Verifone PAY US 26.83 2,957 33.7 12.0 12.0 10.5 22.0 14.5 14.2 0.8 0.0 0.0 3.6 3.2 Global players average 16.6 14.7 12.8 16.8 15.5 14.8 1.0 0.6 0.7 3.3 2.9

Hengbao 002104 CH 14.61 1,604 78.2 20.6 20.3 17.2 35.8 18.1 25.6 N/A N/A N/A 6.5 5.3 Tianyu 300205 CH 12.36 818 39.6 113.6 112.2 58.8 574.8 90.9 N/A N/A N/A N/A 4.7 N/A Shenzhen Xingu 300130 CH 24.58 875 39.8 49.2 49.2 37.8 35.1 30.0 29.3 1.7 0.8 0.8 N/A N/A China listed average 61.1 60.6 37.9 215.3 46.3 27.5 1.7 0.8 0.8 5.6 5.3 Source: Bloomberg, Company Data Guosen Securities (HK) Research

Figure 31 PAX Global forward P/E chart (2 years) (HKD) 15

3 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15

Source: Bloomberg, Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Summary Financial Statements (Year to Dec 31) Profit & Loss (HKDm) FY14A FY15A FY16F FY17F FY18F Financial Ratios FY14A FY15A FY16F FY17F FY18F Revenue 2,373 2,871 3,285 3,750 4,271 Gross profit margin (%) 36.4 38.1 39.4 39.3 39.5 Revenue growth (%) 0.0 21.0 14.4 14.2 13.9 Operating profit margin (%) 19.5 22.9 22.9 23.1 23.8 Cost of sales (1,508) (1,778) (1,990) (2,278) (2,584) Underlying profit margin (%) 16.5 19.2 19.7 19.9 20.5 Gross profit 865 1,092 1,295 1,473 1,688 Net debt/equity (%) (75.3) (69.7) (70.6) (70.8) (70.9) Other income/(expense) 70 109 87 97 109 Net debt/total assets (%) (57.5) (52.6) (56.4) (57.4) (58.3) Operating expenses (472) (544) (629) (704) (779) Current ratio (%) 423 407 497 529 563 Operating profit 463 658 752 866 1,017 Dividend payout (%) 0.0 8.1 0.0 0.0 0.0 Operating profit growth (%) 0.0 42.1 14.4 15.0 17.5 Interest cover (x) Other non-operating inc/(exp) 0 0 0 0 0 Dividend cover (x) 12.4 Finance income 0 0 0 0 0 Acct. receivable turnover days 137.3 145.1 143.7 149.5 Finance expenses 0 0 0 0 0 Acct. payable turnover days 116.4 124.2 111.5 113.9 Associates & JCE 0 0 0 0 0 Inventory turnover days 106.5 103.1 95.0 93.1 Profit before taxation 463 658 752 866 1,017 Cash cycle days 127.4 124.0 127.1 128.7 Taxation (71) (38) (105) (121) (142) Dupont Analysis FY14A FY15A FY16F FY17F FY18F Non-controlling interests 0 0 0 0 0 Tax burden (%) 84.6 94.3 86.0 86.0 86.0 Net profit 392 620 647 744 875 Interest burden (%) 100 100 100 100 100.0 Other Adjustments on UP 0 (69) 0 0 0 Operating profit margin (%) 19.5 22.9 22.9 23.1 23.8 Underlying Profit 392 551 647 744 875 Asset turnover (x) 0.8 0.8 0.7 0.7 Underlying profit growth (%) 0.0 40.7 17.4 15.0 17.5 Leverage ratio (x) 1.3 1.3 1.2 1.2 EPS (HKD) 0.353 0.551 0.575 0.661 0.777 ROA (%) 16.7 14.8 14.7 14.6 Underlying EPS (HKD) 0.353 0.490 0.575 0.661 0.777 ROE (%) 22.1 19.1 18.3 17.9 Underlying EPS growth (%) 0.0 38.9 17.4 15.0 17.5 Source: Guosen Securities (HK) Research DPS (HKD) 0.0 0.04 0.0 0.0 0.0 DPS growth (%) 0.0 0.0 (100) 0.0 0.0 Source: Guosen Securities (HK) Research

Balance Sheet (HKDm) FY14A FY15A FY16F FY17F FY18F Cashflow (HKDm) FY14A FY15A FY16F FY17F FY18F Fixed assets 11 11 13 14 15 Operating profit 463 658 752 866 1,017 Associates & JCE 0 0 0 0 0 Depreciation & amortization 4 5 6 7 8 Others 0 48 47 47 46 Interest expense 0 0 0 0 0 Non-current assets 12 60 60 61 61 Change in working capital (320) (321) (155) (210) (248) Inventories 475 562 562 624 694 Tax paid (18) (69) (105) (121) (142) Debtors & prepayments 912 1,305 1,394 1,646 1,940 Other operating cashflow 25 45 (24) (29) (35) Bank deposits & cash 1,919 2,144 2,614 3,148 3,774 Operating activities 154 317 474 513 600 Others 16 9 9 9 9 Purchase of non-current assets (Capex) (7) (29) (7) (8) (9) Current assets 3,323 4,021 4,578 5,427 6,416 Free cash flow 147 289 468 505 592 Bank & other borrowings 0 0 0 0 0 Disposal of non-current assets 0 0 0 0 0 Trade & payables 424 711 643 749 864 Associates & JCE (net) 0 0 0 0 0 Taxation 78 46 46 46 46 Interest received 24 21 24 29 35 Others 285 231 231 231 231 Dividends received 0 0 0 0 0 Current liabilities 786 988 920 1,026 1,141 Other investing cashflow 0 0 0 1 1 Bank & other borrowings 0 0 0 0 0 Investing activities 16 (8) 17 22 27 Others 0 2 2 2 2 New loans raised 0 0 0 0 0 Non-current liabilities 0 2 2 2 2 Repayment of loans 0 0 0 0 0 Net assets 2,548 3,091 3,716 4,460 5,335 Dividends paid 0 (22) (22) 0 0 Share capital 110 111 111 111 111 Other financing cashflow 74 18 0 (1) (1) Premium & reserves 2,438 2,966 3,591 4,336 5,211 Financing activities 74 (4) (22) (1) (1) Shareholders' funds 2,548 3,078 3,702 4,447 5,322 Inc/(dec) in cash 245 305 469 534 626 Non-controlling interests 0 13 13 13 13 Cash at beginning of year 1,698 1,919 2,144 2,614 3,148 Total equity 2,548 3,091 3,716 4,460 5,335 Foreign exchange effect (24) (80) 0 0 0 BVPS (HKD) 2.3 2.7 3.3 4.0 4.7 Cash at end of year 1,919 2,144 2,614 3,148 3,774 Source: Guosen Securities (HK) Research Source: Guosen Securities (HK) Research

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Pax Global (327 HK) Christopher Tse, +852 2899 6768, [email protected] Jackson Yu, CFA, +852 2899 6773, [email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Notes

Guosen Securities (HK) 63

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China TMT Goldpac (3315 HK) Technology Stagnant Growth 12 May 2016 NEUTRAL We expect Goldpac’s earnings growth to slow in FY16-18 given a. Target price HKD3.10 increasing competition with newcomers entering the market, b. volume growth may slow given the disruptive impact from mobile Last price (11 May 16) HKD3.01 payment and c. overseas business should need some time to take off. Upside/downside (%) 3.0 HSI 20055.29 We forecast its recurring NP CAGR to slow from 36% in FY12-15 to 5% Mkt cap (HKDm/USDm) 2,510/323 in FY15-18. We initiate Goldpac with Neutral rating and TP of HKD3.1. 52 week range (HKD) 2.20 - 6.80 Avg trading volume daily (USDm) 0.6

Card Volume Growth Likely To Slow Free float (%) 56.4% Source: Bloomberg Though card penetration remains low, we believe China is less likely to reach developed countries’ level in the long term. Mobile payment is disruptive to cards Performance as we expect card penetration has reached saturation in most Tier 1/2 cities while (HKD) (%) in Tier 3 and below regions, people adopts mobile payment directly by skipping 100 card payment. Incorporating a replacement cycle for existing card installed base, 6 95 90 we expect new IC cards in China will grow at 15%/13% in FY16/17 down from 5 85 34%/24% in FY14/15. We model Goldpac’s IC card volume to grow at 12% CAGR in 80 4 FY15-18, a much slower growth compared to 74% CAGR in FY12-15. 75 Increasing Competition 3 70 65 We see increasing newcomers entered the payment banking card market in the 2 60 past few years. Despite unstable order flow from banks, these new players have 1 55 diluted the market share of existing industry players in the past few years. In Apr-15 Aug-15 Dec-15 particular, as the industry leader, Goldpac’s market share has come down from Price(LHS) Rel. to HSI(RHS) 21% in 2013 to 19% in 2014 and 15.5% in 2015. We expect the industry competition to remain fierce in FY16-18 as newcomers grasp market by lower ASPs. With limited bargaining power over bank customers, we see consistent downward Performance 1M 3M 12M pressure in Goldpac’s ASP in FY16-18. Absolute (%) (0.7) 29.2 (52.2) Absolute (USD, %) (0.7) 29.7 (52.3) Overseas Need Time To Take Off Relative to HSI (%) 1.2 21.1 (24.6) Goldpac’s philippine operation has started full operation and contributed Rmb3m Source: Bloomberg associate profit in FY15. Backed by UnionPay, Goldpac is planning to expand into Southeast Asian countries such as Thailand and Singapore. Though we believe the overseas can provide an alternative growth source for Goldpac in the long run, we expect it could remain an immaterial profit stream in the next three years. Company background Goldpac Group supplies and distributes financial cards, card Initiate Neutral with TP of HKD3.1 personalization services, on-site card insuance system We forecast Goldpac’s recurring net profit to grow at 7%/4%/4% YoY in solutions, magnetic strip cards and authentication smart cards. According to UnionPay, Goldpac is the largest banking card FY16/17/18 respectively. We believe Goldpac should trade at a discount to its A- supplier with 15.5% market share in 2015. The Company offers share peers given lower ROE, earnings growth, and shorterlisting history. We value its products and services throughout mainland China, Hong Kong and Macao. it at HKD3.1 TP based on 8x FY16F P/E, 1SD below its historical P/E mean. Upside Source: Guosen Securities (HK) Research risks to our call include a better-than-expected ASP. Downside risks include worse- than-expected volume and fluctuations of IC chip costs.

Figure 1: Financial Summary Year to Dec 31(RMBm) FY14A FY15A FY16F FY17F FY18F Jackson Yu, CFA Revenue 1,521 1,685 1,772 1,875 1,969 SFC CE No.: AUX358 Operating Profit 231 263 283 287 296 +852 2899 6773 [email protected] Reported Profit 214 242 260 270 282

Underlying Profit 245 259 277 287 299 Zhenghao Jiang Underlying EPS (Fen) 28.9 30.7 32.9 34.2 35.5 SFC CE No.: BGL257 Underlying EPS growth (%) (3.6) 6.3 7.0 3.9 4.1 +852 2899 6774 [email protected] P/E (x) 8.7 8.2 7.7 7.4 7.1

P/B (x) 1.3 1.2 1.1 1.0 0.9 Christopher Tse Dividend Yield (%) 3.9 5.9 3.7 3.8 4.0 SFC CE No.: BAZ779 Guosen/Consensus (%) (4.1) (5.6) (12.3) +852 2899 6768 [email protected] Source: Company Data, Bloomberg, Guosen Securities (HK) Research

公司报告首次覆盖

金邦达宝嘉 (3315 HK) 中国科技/通信技术增长缓滞 2016 年 5 月 12 日中性我们预测金邦达 16-18 财年的盈利增长将会放缓，原因包括：一、新加入的竞争对手激化市场竞争；二、销量增长可能受移动支付业目标价 HKD3.10 务的冲击而放缓；三、海外业务发展需时。我们预测，公司经常性收盘价净利润的年复合增长率将由 12-15 财年的 36%减慢至 15-18 财年的 (11 May 16) HKD3.01 Upside/downside (%) 3.0 5%。首予中性评级，目标价 3.1 港元。恒生指数 20055.29 总市值 (HKDm/USDm) 2,510/323 预料发卡量增长放缓 52 周最高/最低 (HKD) 2.20 - 6.80 尽管中国的银行卡渗透率仍然偏低，但我们认为中国长远而言也不大可能日均成交额 (USDm) 0.6 追上发达国家的水平。我们相信大部分一二线城市的银行卡渗透率已达到流通量 (%) 56.4% 饱和，而在三线或更次级地区，消费者支付方式将会跳过银行卡支付，直资料来源: 彭博接转为手机支付，因此，移动支付将对银行卡构成冲击。连同现有卡安装量的换卡周期综合计算，我们预测中国新 IC 卡的增长率将由 14/15 财年股价表现 (HKD) (%) 的 34%/24%下降至 16/17 财年的 15%/13%。此外，我们预测金邦达 IC 卡 100 的产量于 15-18 财年将按年复合增长率 12%增长，远低于 12-15 财年的 6 95 74%。 90 5 85 80 4 竞争加剧 75 过去几年，银行卡支付市场不断有新竞争对手加入。尽管银行的订单流不 3 70 65 稳定，但新加入对手在过去几年摊薄了行内现有公司的市占率。具体而言， 2 金邦达作为行业龙头，其市占率由 2013 年的 21%缩减至 2014 年的 19%， 60 1 55 再减至 2015 年的 15.5%。新加入对手通过较低的平均售价抢占市场份额， Apr-15 Aug-15 Dec-15 因此我们预期 16-18 财年的行业竞争将维持激烈。金邦达与银行客户的议 Price(LHS) Rel. to HSI(RHS) 价能力有限，我们预期公司 16-18 财年的平均售价将会持续面对下行压力。

股票数据 1M 3M 12M 海外业务发展需时绝对回报 (%) (0.7) 29.2 (52.2) 金邦达在菲律宾的业务已全面投入营运，15 财年贡献联营公司利润人民绝对回报 (USD, %) (0.7) 29.7 (52.3) 相对 HSI 回报 (%) 1.2 21.1 (24.6) 币 300 万。在银联的支持下，金邦达现正计划扩展业务至东南亚国家，例资料来源: 彭博如泰国和新加坡等。尽管我们认为海外业务长远可为金邦达带来额外增长动力，但预料未来三年海外业务的利润贡献维持微小。公司簡介首予中性评级，目标价港元金邦达宝嘉供应和销售金融卡、金融卡定制化服务、发卡 3.1 系统解决方案、磁条卡以及认证智能卡。根据银联的数我们预测金邦达 16/17/18 财年的经常性净利润将分别按年增长 7%/4%/4%。据，金邦达是最大的银行卡供应商，2015 年市占率为我们认为，基于金邦达的股本回报率和盈利增长较低，加上上市年期更短， 15.5%。公司在中国大陆及港澳地区提供产品和服务。资料来源: 国信证券(香港)研究部股价相对其 A 股同业应有所折让。我们的目标价是 3.1 港元，相当于 16

财年预测市盈率 9 倍，较其历史市盈率平均值低一个标准差。我们评级的上行风险包括平均售价高于预期；下行风险包括销量差于预期和 IC 芯片

成本价格波动。

Figure 2: 盈利预测俞励颉, CFA 证监会中央编号:AUX358 截至 Dec 31(人民币百万) FY14A FY15A FY16F FY17F FY18F +852 2899 6773 营业额 1,521 1,685 1,772 1,875 1,969 [email protected] 经营盈利 231 263 283 287 296 姜正浩净利润 214 242 260 270 282 证监会中央编号: BGL257 实际盈利 245 259 277 287 299 +852 2899 6774 每股实际盈利 (分) 28.9 30.7 32.9 34.2 35.5 [email protected] 每股实际盈利增长 (%) (3.6) 6.3 7.0 3.9 4.1 谢嘉熙市盈率 (x) 8.7 8.2 7.7 7.4 7.1 证监会中央编号:BAZ779 市净率 (x) 1.3 1.2 1.1 1.0 0.9 +852 2899 6768 股息率 (%) 3.9 5.9 3.7 3.8 4.0 [email protected]

国信预测/市场预测 (%) (4.1) (5.6) (12.3)

资料来源：国信证券 (香港) 研究部

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Investment Thesis

The Largest Banking Card Maker in China Goldpac provides one-stop financial card solutions to financial institutions, offering services like consulting, product design, manufacturing, card personalisation and data processing. Financial card issuers, or banks, can fully outsource their card issuance to Goldpac by purchasing its full suite of products and services to assist them in planning and designing new card products. Goldpac could also produce personalised cards and deliver to end-users on behalf of the banks. Customers can also purchase services on an a la carte basis, depending on their needs. Goldpac has three major business lines: i) embedded software and secure payment products (card business), ii) personalisation services, and iii) card issuance system solutions. According to UnionPay, Goldpac is the largest banking card maker in China in terms of volume with about 15.5% market share. Card Volume Growth Likely To Slow Banking card is under-penetrated compared to that in US and Europe. We continue to see a secular trend that China card penetration would gradually grow and replace cash as one of the key payment methods. However, we believe it is less likely to reach developed countries’ card penetration level over the long term as mobile payment migration has clearly become a disruptive trend to card payment. We believe in Tier 1/2 cities banking card already reached saturation while in Tier 3 and below regions, people shift to mobile payment from cash directly by skipping card payment. Incorporating a replacement card cycle of existing card base, we estimate new IC cards in China to reach 900m and 1,020m in 2016 and 2017 respectively, representing 15% and 13% YoY growth. Replacement card volume accounted for 41%-46% of total new IC card in 2016-17. We expect Goldpac’s IC shipment volume to reach 300m in FY18 from 213m in FY15, representing a CAGR of 12%. Increasing Competition Weighs on ASP We see increasing industry competition in financial card manufacturing industry in China despite Its past high industry barrier. Major industry players have been ramping up their capacity in smart cards in 2012-2014 to ride on the IC card demand growth from 2014. Solid track records, third-party certifications and long-term relationship with banks used to be the key industry barrier in the past. However, the increase in industry revenue size in 2012-14 has attracted newcomers entering the industry. For instance, Chutian Dragon Corporation doubled its IC banking card revenue between 2013-15. Smaller players that focused on telecom SIM cards have got the certificates from payment organization and started to receive orders from banks. These newcomers diluted the market share of existing industry players in the past few years. In particular, as the industry leader, Goldpac’s market share has come down from 21% in 2013 to 19% in 2014 and 15.5% in 2015. We expect market share dilution to continue as smaller players rush into the market and dilute the share of existing players.

Guosen Securities (HK) 66

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Overseas Need Time To Take Off We believe the slowing growth in China was one of the key reasons for Goldpac to go overseas and explore new drivers. Revenue from overseas market reached Rmb99m in FY15 or 6% of revenue, up 35% YoY. In Philippine, Goldpac has formed an associate company with some local producers in 2014. With a fully operational personalisation center, Goldpac aims to capture the upcoming chip card migration of the country. In 2015, the associate company contributed Rmb3m profit. Backed by UnionPay, we expect more newsflow on Goldpac overseas expansion in countries such as Thailand and Singapore is likely to come. Though we believe the overseas can provide an alternative growth source for Goldpac over the long run, it should be a new immaterial revenue source for the company in the next three years. We see execution and slowing economy of emerging markets as potential risks.

Initiate Neutral with TP of HKD3.1 We forecast Goldpac’s underlying net profit to grow at 7%/4%/4% YoY in FY16/17/18 respectively driven by continued growth momentum in card business, personalisation, and card issuance services. We believe Goldpac should trade at a discount to its A-share peers given lower ROE, earning growth and shorter listing history. We set our HKD3.1 TP based on a 8x FY16F P/E, or 1SD below its historical mean. Upside risks to our call include a better-than- expected ASP. Downside risks include worse-than-expected volume and fluctuations of IC chip costs.

Guosen Securities (HK) 67

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Focus Charts

Figure 3 Goldpac’s Revenue Breakdown (2015) Figure 4 Goldpac’s Market Share by Volume (%) Card issuance 25 8% 21 20 19 Perso 9% 15.5 15

Cards 5 83% 0 2013 2014 2015 Source: UnionPay, GoldpacGuosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

Figure 5 Goldpac’s IC Card Sales Volume Figure 6 Goldpac’s Revenue Growth in FY16-18

(m) (%) (Rmb m) 350 160 CAGR: 5% 300 2,000 140 300 275 211 189 245 120 164 207 250 139 188 213 1,500 116 156 171 100 140 200 156 80 1,000 150 60 1,551 97 1,390 1,437 1,498 100 1,264 40 500 40 50 17 21 20 -- 0 -- 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F FY14 FY15 FY16F FY17F FY18F IC Card Sales Volume % YoY Cards Perso Card issuance Source: UnionPay, GoldpacGuosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

Figure 7 Goldpac’s Consensus EPS Derating Figure 8 Goldpac’s P/E Band (Rmb) (x) 0.70 25 0.65 0.60 20 +1sd:18x 0.55 0.50 15 Mean: 13x 0.45 0.40 10 -1sd: 8x 0.35 5 0.30 0.25 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 0 FY14 FY15 FY16 FY17 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 Source: UnionPay, GoldpacGuosen Securities (HK) Research Source: Bloomberg, Company Data, Guosen Securities (HK) Research

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Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Valuation

Initiate with Neutral with TP of HKD3.1 We note that Goldpac has no directly comparable peers listed in Hong Kong. All of its peers are listed in China, i.e. Eastcompeace Technology (Eastcompeace) (002017 CH, NR), Hengbao (002104 CH, NR) and Wuhan Tianyu Information Industry (Tianyu) (300205 CH, NR), and in the Netherlands, ie its strategic shareholder Gemalto. A-share listed peers. Goldpac's current 8x/7x FY16/FY17F P/E, compared to its A-share peer average of 49x/29x FY16/17F P/E. We believe this is justified given Goldpac’s shorter listing period, lower ROE compared to its peers. Additionally, Goldpac has experienced sequential earnings downgrades since its IPO in Dec 2013 (Figure 9), partly due to its weak earnings delivery as a result of ASP decline, lower-than-expected volume growth, and continued delays in capacity expansion.

Figure 9 Consensus Estimates for Goldpac’s EPS Consensus earnings (Rmb) deratings 0.70 0.65 0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 FY14 FY15 FY16 FY17 Source: Bloomberg, Guosen Securities (HK) Research

Gemalto. We believe that Gemalto is the undisputed industry leader in terms of advanced digital security technology and track record. However, we think Goldpac deserves to trade at a lower valuation to its long-term strategic shareholder, given its lower earnings growth potential and a focus on card manufacturing. Note that the Dutch firm currently trades at 14x/12x FY16/FY17 P/E respectively.

We see limited share price We forecast Goldpac’s recurring net profit to grow at 7%/4%/4% YoY in FY16/17/18 upside in the near-term. respectively. Compared to consensus earnings estimates, which is now looking at 12%/10% CAGR in revenue/net profit, we are much more conservative on Goldpac’s upcoming growth profile in FY16-18. We set our HKD3.1 TP based on an 8x FY16F P/E, or 1SD below its historical mean and a 40% discount to Gemalto’s FY16F P/E. We see limited share price upside under our investment thesis.

Guosen Securities (HK) 69

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 10 Valuation Comparison 3m avg Company Ticker Price Mkt cap EPS 3YR %chg P/E P/BV ROE Div Yield t/o Lcy USDm USDm CAGR 3m 6m 16F 17F 16F 17F 16F 17F 16F 17F Goldpac 3315 HK 3.01 323 0.6 7.0 29.2 (52.3) 7.7 7.4 1.2 1.1 15.1 14.5 3.7 3.8

Hengbao 002104 CH 14.61 1,604 78.2 25.6 (15.2) (32.1) 20.3 17.2 6.5 5.3 24.6 24.5 N/A N/A Tianyu 300205 CH 12.36 818 39.6 N/A (11.2) (40.8) 112.2 58.8 4.7 N/A 4.1 N/A N/A N/A EastCompeace 002017 CH 12.43 664 17.0 N/A (11.7) (26.0) N/A N/A 5.2 N/A N/A N/A N/A N/A Gemalto GTO NA 57.24 5,832 22.4 48.9 11.7 (4.8) 14.2 12.4 2.0 N/A N/A 13.5 N/A 0.9 Average 48.9 29.4 4.6 5.3 14.4 19.0 N/A 0.9

Source: Company Data, Bloomberg, Guosen Securities (HK) Research

Figure 11 Goldpac’s P/E Band Figure 12 Goldpac’s P/B Band (x) (x) 25 4.0

3.5 20 +1sd:18x 3.0

2.5 +1sd: 2.9x 15 Mean: 13x 2.0 Mean: 2.1x 10 1.5 -1sd: 8x -1sd: 1.3x 1.0 5 0.5

0 0.0 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Source: Company Data, Bloomberg, Guosen Securities (HK) Research Source: Company Data, Bloomberg, Guosen Securities (HK) Research

Guosen Securities (HK) 70

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Risk Factors

Better-than-expected ASP in FY16 . We expect Goldpac’s ASP to decline on the back of cheaper input costs and increasing industry competition going forward. Our sensitivity analysis shows that our estimated EPS is highly sensitive to changes in our assumed gross margin and ASP. If the ASP drops less-than- expected or gross profit margin contracts less severely than we expected, Goldpac’s earnings growth may beat our forecasts. Our sensitivity analysis shows Goldpac's FY16F EPS would fall by 9% if its smart card ASP declines by 10%. Its FY16F EPS would drop 9% if its smart card gross margin contracts by 1ppts. New payment technologies will shape the industry over the long term Card-based payments face competition from other emerging payment technologies, such as mobile phone-based payment systems utilising NFC technology, which could reduce the demand for financial cards. A faster-than-expected migration to mobile payment may reduce the demand for banking card products, which would adversely affect the company’s revenue and earnings growth over the long term. Fluctuations in market prices for IC chips would affect profitability IC chips are the key component used in the production of smart cards, accounting for over 60% of Goldpac’s cost of production. A substantial increase in the cost for IC chips would adversely affect the company’s profitability. Security breaches could bring much damage Goldpac stores sensitive data like personal information and proprietary business information in their database. We believe the company has established security measures for its IT system and infrastructure, which has maximum safeguards against breaches in security. However, if sensitive information is lost, stolen or publicly accessed due to errors made by employees or from other disruptions, Goldpac may face regulatory penalties, loss of customers, damage to its reputation and position in the industry over the long term. Banks and government agencies cutting down on outsourcing Goldpac is currently benefiting from government agencies and banks on the latter outsourcing certain functions such as the production and personalisation of financial cards to third parties. If banks and government agencies cut down their outsourcing and set up their own production facilities, Goldpac’s orders could weaken.

Guosen Securities (HK) 71

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Investment Thesis

Card Volume Growth Likely To Slow

Three structural factors Every Chinese only has 0.3 cards vs the 8-9 financial cards per person in developed regions should drag down the card like Hong Kong, the US, and Europe. Credit cards penetration is low in China, accounting for growth in the long term. roughly 8% of the 5.4bn outstanding cards in 2015. Though we continue to see a secular trend that card penetration should grow and replace cash as one of the key payment methods, we believe it is less likely to reach developed countries’ penetration level as mobile payment migration has clearly become a disruptive force to card payment. We believe the volume growth should slow in FY16-18 as a result of below factors. a. As we highlighted in our previous chapters, we believe the card penetration for Tier 1/2 cities has reached saturation. People in those regions used to be the key driver to new card volume growth given well-established banking infrastructure and credit system. According to PBoC, cities like Shanghai and Beijing had an average card ownership of more than 1 credit cards and 4-5 debit cards in 2015. We believe card penetration could continue to grow moderately in these regions while the growth is likely to slow as a result of the weak macroeconomy, already high card penetration and shifting payment adoption towards mobile payment. b. For lower-tier cities and rural areas, we expect a direct conversion from cash to mobile payment in the next few years, skipping card payment. Population in those cities were facing inferior banking infrastructure in the past, and as a result, card penetration for both debit card and credit cards were low. Cash has been the dominated way to complete most of the transactions there. With a rapid growth of eCommerce, online third-party payment is no longer new for people born after the 1980s, or people in lower tier cities or even rural area. As more and more eCommerce portals are moving to from Tier1/2 cities to lower-tier cities, from PC to mobile, we expect an accelerating adoption of mobile payment in the coming few years as a result of seamless user experience and potential incentives given by Internet giants. c. In contrast to most of the developed countries, credit needs have never been the main reason for credit card application in China. In terms of user experience, credit cards in China also require keying PIN, providing the same user experience of debit cards. A lot of credit card demand was more or less related to banks’ credit installment, rewards and loyalty programme, and merchant incentive programs. Credit card issuance in rural regions substantially lags that in urban regions given inferior credit rating system and less proven records in recurring income there. Backed by the fast growing consumer P2P financing in China, financing needs for people in lower-tier cities and rural areas can be satisfied by P2P Internet financing rather than cards.

Card volume saw slowing Card volume has lost the growth momentum in 2015 (Figure 13). Newly issued card volume growth in 2016 dropped 30% YoY to 506m in 2015 from 722m in 2014. By category debit card grew 12% YoY in 2015 while credit card dropped 5% YoY on card expiration. We see the replacement cycle for old banking card already started in 2015 as newly issued IC chip cards outpaced the new banking cards. China issued 780m new IC cards in 2015, while total new banking card was 506m, indicating some newly-issued IC cards were no longer counted as new debit or credit cards. We estimate about 274m IC cards were replacing outstanding banking cards. Even considering a replacement cycle, the growth for newly-issued IC card slowed to 24% YoY in 2015 from 34% YoY in 2014.

Guosen Securities (HK) 72

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 13 China Card Volume Growth Should Slow Down in 2016-17 2014 2015

(m) 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 2012 2013 2014 2015 2016F 2017F Total 4,391 4,540 4,746 4,936 4,999 5,032 5,252 5,442 3,534 4,214 4,936 5,442 5,972 6,522 % YoY 18.9% 18.4% 19.7% 17.1% 13.8% 10.8% 10.7% 10.3% 19.8% 19.2% 17.1% 10.3% 9.7% 9.2% Newly added 177 149 206 190 63 33 220 190 585 680 722 506 530 550 % YoY 10.6% 7.2% 54.9% (23.4%) (64.4%) (77.9%) 6.8% --% 9.6% 16.2% 6.2% (29.9%) 4.7% 3.8%

By Card Type Debit Card 3,977 4,118 4,310 4,481 4,540 4,599 4,803 5,010 3,203 3,823 4,481 5,010 % YoY 18.7% 18.7% 20.1% 17.2% 14.2% 11.7% 11.4% 11.8% 20.2% 19.4% 17.2% 11.8% Newly added 154 141 192 171 59 59 204 207 539 620 658 529 % YoY 4.1% 18.5% 60.0% (26.6%) (61.7%) (58.2%) 6.3% 21.1% 12.8% 15.0% 6.1% (19.6%) Credit Card 414 422 436 455 424 433 449 432 331 391 455 432 % YoY 20.7% 15.9% 16.0% 16.4% 2.4% 2.6% 3.0% (5.1%) 16.1% 18.1% 16.4% (5.1%) Newly added 23 8 14 19 (31) 9 16 (17) 46 60 64 (23) % YoY 91.7% (61.9%) 16.7% 26.7% N/A 12.5% 14.3% N/A (16.4%) 30.4% 6.7% N/A

IC Card IC Card 720 877 1,040 1,220 1,446 1,652 1,883 2,000 104 593 1,220 2,000 2,900 3,920 % YoY 275.0% 213.2% 173.7% 105.7% 100.8% 88.4% 81.1% 63.9% 352.2% 470.2% 105.7% 63.9% 29.9% 23.2% Newly added 127 157 163 180 226 206 231 117 98 467 627 780 900 1,020 % YoY 44.3% 78.4% 63.0% (15.5%) 78.0% 31.2% 41.7% (35.0%) 476.5% 376.5% 34.3% 24.4% 15.4% 13.3%

Source: PBoC, Guosen Securities (HK) Research

By card category, newly-issued debit card, the main driver of the card volume in 2015, dropped 19% YoY to 529m, mainly due to less new issues from smaller banks (as big-four banks were reporting a 2% YoY growth in debit cards). Credit card volume contracted by 23m in 2015, implying a net reduction of outstanding volume as a result of the expiration.

Figures from big four-four A deeper look at the banking card volume of the big-four banks in China (Figure 14), i.e. banks also indicate slowing Industrial Commercial Bank of China (ICBC), Bank of China (BOC), China Construction Bank card volume growth. (CCB) and Agricultural Bank of China (ABC), shows a similar slowing pattern since 2014. Total debit and credit card issued by these four was 2.9bn by end-2015, accounting for 53% of total outstanding cards in China. Newly-issued card volume dropped 3% YoY in 2014 due to the one-time upgrade of card standards in China following the release of PBoC 3.0. However, the growth remains soft entering 2015 with 0.3% YoY growth. The largest volume contributor for banking cards in 2015, CCB, issued 122m new cards in 2015 while after its 2015 results, the bank particularly highlighted its “Mobile First” strategy, aiming to improve the payment user experience going forward. On the merchants’ side, the group particularly highlighted that it will push mobile payment technologies, such as UnionPay QuickPass, Apple Pay and Samsung Pay and QR Code Payment for difference consumer scenarios. We forecast total debit and credit cards would grow at 10% and 9% in 2016 and 2017, respectively implying an annual addition of 530m and 550m respectively, compared to 506m in 2015. Even considering a replacement card demand, we expect total new IC cards in China to grow at 15% and 13% in 2015 and 2017 to 900m and 1,020m, respectively (Figure 13). Replacement card volume should account for 41%-46% of total new IC card in 2016-17.

Guosen Securities (HK) 73

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 14 Big-four Banks Cards’ Volume 1H13 2H13 1H14 2H14 1H15 2H15 2011 2012 2013 2014 2015 Outstanding cards (m) ICBC 499 578 620 663 707 746 413 469 578 663 746 BOC 310 344 375 410 441 471 225 280 344 410 471 CCB 530 584 638 698 756 820 396 480 584 698 820 ABC 625 676 719 771 812 866 489 583 676 771 866 Total Big-four 1,965 2,183 2,352 2,542 2,715 2,902 1,523 1,812 2,183 2,542 2,902

% YoY ICBC 13.7% 23.2% 24.2% 14.7% 14.0% 12.5% 16.3% 13.6% 23.2% 14.7% 12.5% BOC 22.5% 23.2% 21.0% 19.0% 17.6% 14.9% 31.7% 24.4% 23.2% 19.0% 14.9% CCB 22.2% 21.6% 20.3% 19.5% 18.5% 17.5% 27.8% 21.2% 21.6% 19.5% 17.5% ABC 19.0% 16.0% 15.0% 14.0% 12.8% 12.3% 20.3% 19.1% 16.0% 14.0% 12.3% Total Big-four 19.0% 20.5% 19.7% 16.5% 15.4% 14.2% 22.6% 19.0% 20.5% 16.5% 14.2%

1H13 2H13 1H14 2H14 1H15 2H15 2011 2012 2013 2014 2015 Newly added cards (m) ICBC 31 78 42 43 44 39 58 56 109 85 83 BOC 30 35 30 35 31 30 54 55 65 65 61 CCB 50 54 54 60 58 63 86 84 104 114 122 ABC 43 51 43 52 40 54 83 94 93 95 95 Total Big-four 153 218 170 189 173 187 281 289 371 359 360

% YoY ICBC 14.4% 164.9% 38.8% (45.6%) 3.4% (8.6%) (11.8%) (2.7%) 93.5% (21.9%) (2.6%) BOC 7.6% 29.1% 1.3% 0.5% 2.4% (14.5%) 931.4% 1.2% 18.2% 0.8% (6.7%) CCB 32.6% 15.8% 8.2% 11.4% 7.6% 6.3% 156.0% (2.6%) 23.3% 9.9% 6.9% ABC 16.7% (11.1%) 1.1% 2.1% (6.2%) 4.8% 89.1% 13.3% (0.3%) 1.7% (0.2%) Total Big-four 19.0% 36.0% 11.0% (13.0%) 2.1% (1.3%) 89.5% 2.8% 28.4% (3.1%) 0.3%

Note: the banking card volume includes both debit cards and credit cards, but excludes social financing cards and express settlement cards. Source: ICBC, BOC, CCB, ABC, Guosen Securities (HK) Research

We expect Goldpac’s As such, we expect the growth for Golpdac’s IC card sales volume should slow in FY16-18, as a volume to slow in FY16-18 result of slowing industry volume growth. Goldpac sold 213m IC cards in 2015, up 37% YoY, driven by increasing banking cards and social financing cards. We model Goldpac’s IC volume to grow at 15%/12%/9% YoY in FY16/17/18 driven by steady growth in new card demands and replacement orders for existing magnetic card installed base.

Figure 15 Goldpac’s IC Card Volume Growth (m) (%) 350 Goldpac was listed 160 143 in Dec 2013 300 300 275 140 245 120 250 94 213 100 200 156 80 150 60 97 61 100 37 40 20 40 15 50 12 17 21 9 20 -- 0 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F IC Card Sales Volume % YoY Source: Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 74

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Increasing Competition Financial card manufacturing industry in China used to be a high industry barrier. A few top leading manufacturers include Goldpac, Hengbao (002104 CH, NR), Giesecke & Devrient (G&D, Not Listed), China Banknote (Not Listed) and Eastcompeace (002107 CH, NR), accounts for about 70% market share. Among them, G&D is a multinational corporation, while China Banknote is a subsidiary of state-owned enterprise China Banknote Printing and Minting Corp. Major industry players have been ramping up their capacity in smart cards in 2012-2014 to ride on the demand growth from 2014.

Past industry barriers Solid track records. Banks always require high-quality services, reliability and security of information in issuing cards – which means that card issuers usually need a stable, long-standing relationship with trusted service providers. We believe existing players have substantial advantages over new entrants. Goldpac’s long-term customers are mainly national and regional state-owned commercial banks as well as foreign banks in Hong Kong and Macao. Third-party certification. Relevant certification from payment card networks such as Visa, MasterCard and UnionPay is a must for banks when they deal with card suppliers. According to Goldpac, the company is the only card services provider in China that is certified by Visa, MasterCard, American Express, China UnionPay, JCB and Diners Club International. This is why Goldpac can expand its presence into Hong Kong, Macao, and other ASEAN countries, as international issuers usually work with a wider circle of card organizations. Long-term relationship. Once the relationships between card suppliers and banks are cemented, banks usually take a substantial amount of time to conduct due diligence and both parties have to spend the time to coordinate orders and delivery. Given the reliability and security involved, the cost of switching between suppliers for the banks is very high.

We believe increasing Increasing Competition The industry market size grew tremendously in 2012-14 after PBoC’s competition weighs on mandate on card replacement to chip-based cards from magnetic cards. Frost & Sullivan industry ASP estimates total IC card sales value increased from Rmb1.6bn in 2012 to Rmb6.5bn in 2014, representing a 101% CAGR. The increase in market size attracts some new comers into the industry, for instance, Chutian Dragon Corporation doubled its IC banking card revenue between 2013 to 2015. Some smaller players which focused on telecom SIM cards have got the certificates and start to receive orders from banks. These newcomers diluted the market share of top five industry players in the past few years. In particular, as the industry leader, Goldpac’s market share has come down from 21% in 2013 to 19% in 2014 and 15.5% in 2015.

Figure 16 Goldpac’s Market Share by Volume Figure 17 Chutian Dragon’s Revenue in Banking Card (%) (Rmb m) 25 700 21 608 20 19 600 550

15.5 500 15 400 363 290 10 300

200 5 100

0 0 2013 2014 2015 2013 2014 9M14 9M15 Source: UnionPay, Guosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 75

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

We believe industry competition remains fierce in FY16-18 posting risks on industry ASP. Goldpac’s ASP for IC card reported a YoY drop of 6%/17% in FY14/15 on rising competition and lower chip cost. We expect ASP downward trend to continue in FY16-18 given limited bargaining power over banks and increasing industry competition. Overseas Expansions Take Time To Take Off

Overseas is likely to be We believe slowing China growth was one of the key reasons for Goldpac to go overseas to long-term growth driver explore new drivers. Revenue from overseas market amounted to Rmb99m in FY15, or 6% of though it sill needs some total revenue, up 35% YoY. time to take off Previously during IPO, Goldpac plans use 10% of its IPO proceeds, or HKD95m, for M&A expansions outside China, according to its listing prospectus. In overseas markets, Europe has largely adopted EMV standards over the past decade. Japanese banks usually handle their own card manufacturing and personalisation process in-house in order to avoid any possible personal information leaks. Southeast Asia can be the next spot for the company. In Philippine, Goldpac has formed an associate with some local producers in 2014. Goldpac provides personalisation services there aiming to capture the upcoming chip card migration of the country. In 2015, the associate company contributed Rmb3m profit. Backed by UnionPay, more newsflow on Goldpac overseas expansion in countries such as Thailand and Singapore is likely to come. We believe overseas markets may be a new immaterial revenue source of the company in the next 3-5 years.

Figure 18 Goldpac’s Global Expansion Plan

Source: Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 76

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Financial Forecasts Expect 6% CAGR Revenue growth in FY15-18 Goldpac recorded a rapid revenue and earnings growth in FY10-13. However, both of its top line and bottom line starts to slow from FY14 due to continued drop in ASP, margin pressure, and slower-than-expected volume growth.

We forecast card business Cards. Goldpac has no capacity addition plan in sight. In terms of volume, we expect to slow in FY16-18 on lower Goldpac's total magnetic cards and IC cards to grow at an 8% CAGR in FY15-18, mainly driven volume growth and continued ASP pressure. by the growth from IC card. We expect its magnetic card volume to maintain at 60m in FY16- 18 mainly driven by resilient demand for prepaid cards and gift cards. We expect its IC shipment volume to reach 300m in FY18 from 213m in FY15, representing a CAGR of 12%. Meanwhile, competition in the industry has been growing since 2010, as other competitors have been increasing capacity to capture smart card demand. Goldpac’s ASP for IC card reported a drop of 6%, 17% in FY14/15 mainly due to rising competition and lower chip cost. We expect such trend to continue in FY16-18 given continued pressure from banks on lower procurement costs and increasing industry competition. We model 10%/7%/5% decline in ASP in FY16/17/18 and anticipate its IC card margin to decline to Rmb5 per card in 2018 from Rmb6.3 per card in 2015. Personalisation and card issuance business. We expect its personalisation services business to grow at 10% in FY16-FY18 driven by increasing demand from banks on outsourcing its personalisation capabilities to banks. Card issuance business should grow at 18%/15%/12% in FY16/17/18 driven by recurring demand for on-site card issuance solutions. With higher revenue growth from personalisation and card issuance business, for the first time, Goldpac’s revenue is likely to shift out from card manufacturing to services oriented business. We forecast Goldpac’s revenue to grow at a CAGR of 5% in FY15-18, much slower than its 36% revenue CAGR in FY12-15. Gross margin to decline in FY16-FY18. The gross margin for smart cards is lower than that of magnetic stripe cards mainly due to higher IC chip costs. Goldpac uses IC chips produced by NXP Semiconductors and Infineon (IFX GR, NR). IC chips usually account for more than half of the production cost of smart cards.

Figure 19 Goldpac’s Revenue Figure 20 Goldpac’s Revenue breakdown

(Rmb m) (%) 100 CAGR: 5% 8 8 9 10 11 2,000 90 9 9 211 10 10 11 189 80 164 139 207 188 70 1,500 116 156 171 140 60 50 1,000 40 83 83 81 80 79 1,437 1,498 1,551 1,264 1,390 30 500 20 10 -- 0 FY14 FY15 FY16F FY17F FY18F FY14 FY15 FY16F FY17F FY18F Card Personalisation Card issuance system Card Personalisation Card issuance system Source: Company Data, Guosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

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Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

We witnessed a substantial decline of IC SIM price in the past few years due to: a. price reduction by NXP and Infineon, when both of them sees a substantial lift in production efficiency; b. the pricing war between a few semiconductor operators following their new capacity going on stream; and c. customers tend to select chips with less memory putting pressure on blended chip cost.

We expect a gradual decline Goldpac’s gross margin has contracted from 25% in 2012 to 24% in 2015 because of a product of gross margin in Fy16-18 shift from magnetic cards to IC cards that have a relatively lower margin. We expect the on ASP decline. company’s gross margin for cards to stables at about 23-14% in FY16-FY18, compared to 24% in 2015. Meanwhile, the gross margin for its high-margin personalisation business could contract as increasing new players enter the market. All in all, we expect Goldpac’s blended gross margin to decline from 26.4% in FY15 from 25.2% in FY18.

Figure 21 Goldpac’s Gross Margin (%) 45

40 40 40 38 41 39 35 38 35 33 35

30 32

25 25 24 24 23 23

20 FY14 FY15 FY16F FY17F FY18F Card Personalisation Card issuance system Source: Company Data, Guosen Securities (HK) Research

Operating margin. We forecast Goldpac's opex-to-sales ratio to decline gradually in FY16-18, mainly due its operating leverage as its revenue continues to grow. However, due to a slight gross margin contraction, we forecast operating margin to decline gradually to 15% in FY18 from 16% in FY16. Share-based compensation. Goldpac issued pre-IPO share options in Dec 2013 to its employees, with total shares of 36m. The company reported share-based compensation expenses of Rmb30m and Rmb17m in FY14 and FY15, respectively. We expect the company to report a share-based compensation of Rmb17m throughout FY16-18 on the back of continued non-cash expenses on this counter. Net profit and recurring net profit. We forecast Goldpac’s reported net profit to grow at 7%/4%/4% in FY16/17/18 respectively driven by continued growth momentum in Goldpac card business as well as growth from personalisation and card issuance services. After stripping out non-cash share-based compensation, we forecast Goldpac’s underlying profit to grow 7% CAGR in FY15-18, with its profit reaching Rmb299m in FY18, from Rmb259m in FY15.

Guosen Securities (HK) 78

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 22 Key Model Assumptions FY14 FY15 FY16F FY17F FY18F 1H14 2H14 1H15 2H15 Shipment (m) Magstripe 110 60 60 60 60 60 50 32 28 IC 156 213 245 275 300 81 75 104 109 Total 266 273 305 335 360 141 125 136 137

YoY Magstripe (24.7%) (45.5%) --% --% --% (46.7%) (44.0%) IC 60.8% 36.5% 15.0% 12.2% 9.1% 28.4% 45.3% Total 9.5% 2.6% 11.7% 9.8% 7.5% (3.5%) 9.6%

ASP (Rmb/card) Magstripe 0.80 0.90 0.80 0.80 0.80 0.85 0.59 0.85 0.74 IC 7.6 6.3 5.7 5.3 5.0 8.1 7.1 6.7 5.9 Blended 4.8 5.1 4.7 4.5 3.6 5.0 4.5 5.3 4.9

YoY Magstripe 2.6% 12.5% (11.1%) --% --% 0.8% 26.6% IC (6.4%) (17.1%) (10.0%) (7.0%) (5.0%) (16.9%) (16.7%) Total 28.8% 7.1% (7.4%) (5.1%) (18.8%) 6.9% 8.1%

Card Revenue (Rmb m) Magstripe 79 48 48 48 48 50 29 27 21 IC 1,186 1,342 1,389 1,450 1,503 653 533 697 645 Total 1,264 1,390 1,437 1,498 1,551 702 562 724 666

YoY Magstripe (27.9%) (39.1%) (0.0%) --% --% --% --% (45.0%) (29.1%) IC 50.5% 13.2% 3.5% 4.4% 3.6% --% --% 6.7% 21.1% Total 41.0% 9.9% 3.4% 4.2% 3.5% --% --% 3.1% 18.5%

Card Gross Margin (%) Magstripe 52.9% 46.0% 46.0% 46.0% 46.0% 39.0% 76.4% 46.0% 46.0% IC 23.0% 23.0% 23.0% 22.5% 22.5% 24.7% 20.9% 23.4% 22.6% Total 24.9% 23.8% 23.8% 23.3% 23.2% 25.8% 23.7% 24.2% 23.3%

FY14 FY15 FY16F FY17F FY18F 1H14 2H14 1H15 2H15 Revenue (Rmb m) Cards 1,264 1,390 1,437 1,498 1,551 702 562 724 666 Personalisation 140 156 171 188 207 70 70 81 74 Card issuance system 116 139 164 189 211 50 67 68 71 Total 1,521 1,685 1,772 1,875 1,969 822 699 874 811

YoY Cards 40.9% 9.9% 3.4% 4.2% 3.5% 61.2% 21.8% 3.1% 18.5% Personalisation 22.4% 10.9% 10.0% 10.0% 10.0% 26.4% 18.6% 15.8% 6.1% Card issuance system 15.8% 19.5% 18.0% 15.0% 12.0% 1.1% 29.8% 37.9% 5.9% Total 36.8% 10.8% 5.2% 5.8% 5.0% 52.2% 22.2% 6.3% 16.0%

Gross Margin (%) Cards 24.9% 23.7% 23.8% 23.3% 23.2% 25.8% 23.7% 24.2% 23.3% Personalisation 40.8% 39.1% 38.0% 35.0% 32.0% 49.5% 32.1% 39.9% 38.2% Card issuance system 40.3% 39.6% 38.0% 35.0% 33.0% 46.0% 36.0% 40.1% 39.1% Total 27.5% 26.4% 26.5% 25.6% 25.2% 29.0% 25.7% 26.9% 26.1%

Source: Company Data, Guosen Securities (HK) Research

Guosen Securities (HK) 79

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 23 Profit & Loss Statement (Rmb m) FY14 FY15 FY16F FY17F FY18F 1H14 2H14 1H15 2H15 Revenue 1,521 1,685 1,772 1,875 1,969 822 699 874 811 YoY 36.8% 10.8% 5.2% 5.8% 5.0% 52.2% 22.2% 6.3% 16.0% Cost of Sales (1,103) (1,240) (1,303) (1,395) (1,473) (584) (519) (639) (599) Gross Profit 419 445 469 480 496 239 180 235 211 Gross Margin 27.5% 26.4% 26.5% 25.6% 25.2% 29.0% 25.7% 26.9% 26.1% Other Operating Income 25 41 43 45 48 9 16 17 24 Selling & Distribution Costs (116) (113) (117) (122) (126) (56) (60) (52) (60) Admin Costs (27) (31) (30) (31) (32) (14) (13) (15) (15) R&D Cost (70) (80) (82) (86) (91) (32) (38) (42) (38) Opex (213) (223) (229) (239) (248) (102) (111) (110) (113) EBIT 231 263 283 287 296 146 85 142 123 EBIT Margin 15.2% 15.6% 16.0% 15.3% 15.0% 17.7% 12.2% 16.3% 15.1% YoY 10.0% 14.1% 7.6% 1.2% 3.2% 42.7% (21.0%) (2.3%) 44.4% EBITDA 288 320 346 355 370 157 100 162 143 EBITDA Margin 18.9% 19.0% 19.5% 18.9% 18.8% 19.1% 14.3% 18.6% 17.6% YoY 24.3% 11.2% 8.1% 2.7% 4.2% 53.3% (19.9%) 3.1% 42.4% Finance Income 28 30 32 42 47 15 13 13 18 Finance Cost (1) (0) ------(0) (1) (0) (0) PBT 257 296 318 331 346 160 96 154 144 Tax (43) (54) (58) (61) (63) (42) (1) (28) (26) Reported Net Profit 214 242 260 270 282 118 95 126 118 YoY 51.6% 13.3% 7.4% 4.1% 4.3% 45.2% 60.3% 6.6% 23.3% Reported Net Profit Margin 14.0% 14.4% 14.7% 14.4% 14.3% 14.4% 13.6% 14.4% 14.5% Underlying Net Profit 245 259 277 287 299 130 115 133 128 Underlying Profit Margin 16.1% 15.4% 15.6% 15.3% 15.2% 15.8% 16.4% 15.2% 15.8% YoY 42.2% 5.8% 7.0% 3.9% 4.1% 59.5% 93.0% 2.1% 11.4% Dividend Payable 83 125 78 81 85 DPS (Fen) 10.0 15.0 9.4 9.8 10.2 Payout Ratio 38.9% 51.5% 30.0% 30.0% 30.0%

Operating Metrics Selling & Dist. Cost % Revenue 7.6% 6.7% 6.6% 6.5% 6.4% 6.8% 8.6% 6.0% 7.4% Admin Cost % Revenue 1.8% 1.8% 1.7% 1.7% 1.6% 1.7% 1.9% 1.7% 1.9% R&D Cost % of Revenue 4.6% 4.7% 4.6% 4.6% 4.6% 3.9% 5.4% 4.8% 4.6% Opex % Revenue 14.0% 13.2% 12.9% 12.8% 12.6% 12.5% 15.9% 12.6% 13.9% Opex % Revenue, excl SBC 12.0% 12.2% 11.9% 11.8% 11.7% 11.0% 13.2% 11.8% 12.6% Effective Tax Rate (%) 16.8% 18.3% 18.3% 18.3% 18.3% 26.3% 1.0% 18.4% 18.0% Effective Tax Rate (%), excl SBC 15.0% 17.4% 17.4% 17.5% 17.5% 24.5% 0.8% 17.7% 16.8%

Source: Company Data, Guosen Securities (HK) Research

Balance sheet and cash flow Working capital. We forecast Goldpac's working capital to slightly improve in the next three years on the back of its increasing bargaining power over upstream suppliers. Its accounts receivable days increased to 89 days in 2015 from 62 days in 2014, given longer financing terms are given to its customers. We expect Goldpac's AR days to gradually come down to 71 days in 2018 and forecast flat inventory days in FY16-FY18 – which is stable compared to previous years. We believe its account payable days could increase to 213 days in FY18 from 204days in 2015 on the back of its strong bargaining power over chip suppliers. Capex. Goldpac is a net cash company with no debt after its IPO. We expect the company to incur its capex Rmb50m in 2016, driven by its maintenance capex of personalisation services center.

Guosen Securities (HK) 80

Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 24 Balance Sheet (Rmb m) FY14 FY15 FY16F FY17F FY18F Non-Current Assets Property, Plant And Equipment 186 196 201 199 192 Land Use Rights 1 1 1 1 1 Goodwill -- 1 1 1 1 Intangible Assets 16 14 14 14 14 Interests in associates -- 38 41 44 48 Deposits Paid for Acquisition of Pp&E 12 6 6 6 6 Amount due from an associate -- 1 1 1 1 Pledged bank deposit -- 100 100 100 100 Fixed bank deposits -- 110 110 110 110 Total 215 467 475 477 473

Current Assets Inventory 285 321 336 360 380 Receivables 312 512 354 375 394 Account Receivable 301 493 ------Other Trading Receivables 12 20 ------Due From A Related Person -- 4 4 4 4 Other Financial Assets 740 ------Pledged Deposits 23 22 22 22 22 Fixed Deposits 618 296 296 296 296 Cash And Cash Equivalents 125 984 1,368 1,566 1,776 Total 2,102 2,139 2,381 2,623 2,872 Total Assets 2,317 2,607 2,856 3,100 3,344

Current Liabilities Payables And Accruals 670 715 782 837 884 Payable And Accrued Charges 547 567 ------Retal Received In Advance 123 148 ------Due To Related Party ------Government Grants 5 19 19 19 19 Bank Loans - St ------Derivative Financial Instruments ------Income Tax Payable 18 36 36 36 36 Total 693 770 837 892 939

Non-Current Liabilities Government Grants Deferred Taxation 13 23 23 23 23 Total 13 23 23 23 23 Total Liabilities 706 793 860 915 962

Equity Issued Capital 1,175 1,190 1,190 1,190 1,190 Reserves 436 624 806 995 1,192 Total Equity 1,611 1,814 1,996 2,185 2,383 Inventory Days 92 89 92 91 92 AR Days 62 89 89 71 71 AP Days 193 204 210 212 213 Cash cycle days (39) (25) (28) (50) (50)

ROE 16.3 15.1 14.5 13.7 13.1 ROA 10.6 9.9 9.7 9.3 8.9 Net cash 1,505 1,302 1,686 1,884 2,094

Source: Company Data, Guosen Securities (HK) Research

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Goldpac (3315 HK) Jackson Yu, CFA, +852 2899 6773, [email protected] Christopher Tse, +852 2899 6773,[email protected] Zhenghao Jiang, +852 2899 6774, [email protected]

Figure 25 Cash Flow Statement (Rmb m) FY14 FY15 FY16F FY17F FY18F Operating Activities Profit Before Taxation 257 296 318 331 346 Investment Income From Other Financial Assets (10) (13) ------Interest Income (28) (30) (32) (42) (47) Interest Expenses 1 0 ------Non-Cash Finance Charge On Share Repurchase Obligations ------Depreciation of Property, Plant And Equipment 27 40 46 51 57 Amortisation 2 2 ------Share of Associate Interests -- -- (3) (3) (3) Equity-Settled Share-Based Payments 30 17 ------Share of profit of associates -- (3) (3) (3) (3) Other Non-cash Items 9 2 ------Operating Profit Before Change In Working Capital 288 311 326 335 350 Increase In Inventories (18) (40) (15) (24) (20) (Increase) Decrease In Trade And Bills Receivables (109) (192) 158 (21) (19) (Increase) in amount due from a associate -- (5) ------(Increase) Decrease In Other Receivables And Prepayments 0 (5) ------Increase In Trade And Bills Payables 118 20 67 55 47 Increase (Decrease) In Other Payables 54 24 ------Increase (Decrease) In Government Grants 2 14 ------Working Capital Changes 46 (184) 210 11 8 Taxation Paid (44) (27) (58) (61) (63) Net Cash Generate From Operations 291 100 477 285 294

Investing Activities Investment Income Received From Other Financial Assets 10 13 ------Interest Received 28 30 32 42 47 Purchase of PP&E (89) (23) (50) (50) (50) Deposits Paid for Acquisition of Pp&E (12) (21) ------Withdrawals of Fixed Bank Deposits 2,857 1,195 ------Purchase of Other Financial Assets (1,917) (409) ------Redemption of Other Financial Assets 1,177 1,149 ------Placement of Fixed Bank Deposits (2,474) (1,014) ------Placement of Pledged Bank Deposits (63) (146) ------Withdrawals of Pledged Bank Deposits 68 46 ------Others -- (34) ------Net Cash Used In Investing Activities (415) 787 (18) (8) (3)

Financing Activities Dividends Paid (32) (66) (78) (81) (85) Interest Paid (1) (0) ------Share repurchase -- (3) 3 3 3 Bank Loans Raised 71 5 ------Repayment of Bank Loans (86) (5) ------Others 2 8 ------Net Cash From (Used In) From Financing Activities (46) (61) (75) (78) (81) ------Cash And Cash Equivalents At Beginning of Year 594 423 1,251 1,636 1,834 Net Increase/(Decrease) In Cash And Cash Equivalents (171) 827 384 198 209 Effect of Forex Changes 0 1 ------Cash And Cash Equivalents At End of Year 423 1,251 1,636 1,834 2,043 Cash Balance Check Balance Sheet Bank Cash 125 984 1,368 1,566 1,776 Fixed Bank Deposits Which Matured Within Three Months 298 268 268 268 268 End cash balance 423 1,251 1,636 1,834 2,043

Source: Company Data, Guosen Securities (HK) Research

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Appendix A: EMV in China

Moving Towards Safer Payment Cards Compared to magnetic stripe cards, smart cards have substantial advantages in terms of security, functionality, and expandability. EMV was rolled out by Europay International, MasterCard (MA US, NR) and Visa (V US, NR) in the late 1990s. It has been viewed as one of the most effective tools in fighting card fraud worldwide. The EMV standard requires the use of a chip-embedded card and a personal identification number (PIN) for the card holder. The standard defines certain aspects of smart card deployment, including the visual appearance of a card, terminal hardware and software, personalisation, cryptography, transaction processing algorithms and more. EMVCo – owned by American Express Co (AXP US, NR), Japan Credit Bureau (JCB), MasterCard, China UnionPay (UnionPay) and Visa – manages, maintains and enhances the EMV-integrated circuit card specification to ensure global interpretability of chip-based financial cards with acceptance devices. These include point of sale (POS) terminals and automated teller machines (ATMs). Some overseas EMV infrastructure supports both contactless payments as well as NFC payments. Merchants can install dual contact/contactless POS terminals that accept contact EMV, contactless EMV, and NFC mobile payments. EMV cards also prevent fraud at the retail POS as well as online fraud. According to EMVCo, the EMV standards body, the adoption of EMV technology worldwide has continued to grow in recent years. The adoption rate in the Asia-Pacific (including China) was 17% in 4Q13 vs 54% in Canada/Latin America and 82% in Western Europe. The US, where the adoption rate has been historically low, officially kicked off this migration in 2013.

Figure 26 Global EMV Migration Chart

Source: Company Data, Guosen Securities (HK) Research

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Since 2010, EMV migration in China has accelerated. In Mar 2011, PBOC released its Several Opinions Regarding the Promotion of Financial IC Card announcement, which detailed its guidance on EMV standards in China and its roadmap. This notice officially launched a nationwide timeline for a smart card migration and encourages the adoption of financial IC cards in the provision of social security benefits. In Feb 2013, PBoC released PBoC 3.0 specification which added the specification of multi-application areas of IC cards on the basis of the PBoC 2.0 released in Mar 2005. In 2014, PBoC promulgated the Notice of the General Office of the People’s Bank of China on Matters concerning Gradually Prohibiting the Fallback Transactions on Financial IC cards to lay the foundation for ceasing the issuance of magnetic stripe cards completely. The PBOC roadmap requires all banks to retire the issuance of magnetic stripe cards by a stipulated date. This means that all new cards issued from 1 Jan 2015 will be smart chip ones.

Figure 24 China’s PBoC Standards Migration

2003 PBoC held research 2013 PBoC released the PBoC conference meeting on the 3.0 specification which added migration roadmap to EMV 2008 PBoC issued "Primary 2010 PBoC released the specification of multi- and China EMV specifications Standards for Financial IC "Standards of Financial IC application areas of IC cards Cards in China Cards" on the basis of the PBoC 2.0

2005 PBoC released the first 2009 PBoC issued bulk of 2014 PBoC laid the official document on financial standards in POS terminals, 2011 PBOC released its foundation for ceasing the card - "Standards of IC ATM machines and financial Several Opinions Regarding issuance of magnetic stripe Financial cards in China" card networks. the Promotion of Financial IC cards completely. (Pubic 2.0) Card announcement, which detailed its guidance on EMV standards in China and its roadmap

Source: PBoC, Guosen Securities (HK) Research

Figure 28 Pros & Cons of Different Payment Method Payment methods Cash Cheque Cards Online payments Prepaid cards Advantages Traditional payment Relatively transparent Convenient, portable Transparent Specialised usage, like method made without regulations and and low-risk (especially regulations and prepaid phone cards any technical detailed transaction for smart cards); detailed transaction and shopping cards; difficulties; records Widely used in both record Diversified issuers Widely accepted small- and large-value payments

Disadvantages Limitations on Usually used in large- Limitations on Hidden risks in security; Limited number of portability and safety in value payments ; portability and safety Relatively complex to accepting merchants the case of large-value Complex and when transactions use; result in a smaller purchases and remote inconvenient payment involve large payment Not highly accepted by chance of these being payments procedures amounts and long users yet used geographical distance

Source: Company Data, Guosen Securities (HK) Research

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Appendix B: Corporate Background

Established by the Chairman Mr Lu Run Ting in 1995, Goldpac provides one-stop financial card solutions to financial institutions, offering services like consulting, product design, manufacturing, card personalisation and data processing. Financial card issuers, or banks, can fully outsource their card issuance to Goldpac by purchasing its full suite of products and services to assist them in planning and designing new card products. Goldpac could also produce personalised cards and deliver to end-users on behalf of the banks. Customers can also purchase services on an a la carte basis, depending on their needs. Goldpac has three major business lines: i) embedded software and secure payment products (card business), ii) personalisation services, and iii) card issuance system solutions. Card business. Goldpac designs and manufactures magnetic stripe cards and smart card products for customers, who use them as financial cards like debit cards, credit cards, charge cards and social security cards. Magnetic stripe cards are a mature technology to store cardholder information on a band of magnetic material on the card. IC chip cards are embedded with chips that have greater data storage capacity than a magnetic stripe card and can be programmed with a variety of security features that can interface with chip card compatible automatic teller machines (ATMs) and point-of-sale (POS) terminals to authenticate transactions. Personalisation services. Personalisation services include a series of customised services involved in the packaging and distribution of financial cards. Goldpac usually processes loading personal data (such as the cardholder’s name, account number and expiration date) or a premium value application onto the IC chips embedded in smart cards. It also embosses and prints customised card bodies for customers, while also customising the associated packaging and card mailers. When requested by customers, it also distributes personalised products directly to end-users. Card issuance. The company provides card issuance system solutions to customers in China. Goldpac can provide issuance systems for both high-volume industrial size card personalisation operations and desktop card issuance systems rapidly and at low volumes for end-users who are nearby, ie within bank branches. On top of that, it also maintains regular contact with customers and keeps abreast of their future plans to secure payment solutions, craft new requirements for products and services and win upcoming tenders. Goldpac generally uses this information to support its R&D and maintain a pipeline of new products to meet customer needs. The successful pre-sale consultation ensures the company will have a high rate of wins when bidding for tenders from customers. Banks usually choose their card makers through a public tendering process based on the applicants’ track record, technology requirement and services offered. We note that Goldpac has achieved a high rate of wins over the past three years. About Gemalto Gemalto (GTO NA, NR) is a leading digital security services provider that develops and installs secure software in diverse products including SIM cards, banking cards, tokens, ID cards etc. The company’s platform and services continuously monitor and manage these devices, checking identities and managing transactions. The embedded software and products include payment cards, travelling passes, password generators, employee IDs, and government IDCs. Gemalto is able to personalise these devices with their identities of their customers and provide services continuously to monitor and manage these secured devices.

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The company’s key clients come from 190 countries and comprise national administrations, mobile operators, banks and financial institutions, transport operators and a large number of industries. It also develops secure software and operating systems which can be embedded in many kinds of device, like SIM cards, banking cards, tokens, electronic passports and ID cards.

Figure 29 Gemalto’s Revenue Breakdown (2015) Figure 30 Gemalto’s Revenue Geographical Breakdown (2015)

Patents & Others 1% Asia Pacific 18%

Europe, CIS, Mobile Middel East 41% Payment & Identity & Africa 58% 44% North & South America 38%

Source: Company Data, Guosen Securities (HK) Research Source: Company Data, Guosen Securities (HK) Research

Shareholding Structure & Management

Figure 31 Goldpac’s Shareholding Structure

Gemalto Mr Lu Run Ting (The Netherlands) (Chairman)

100% 100%

GISA GIHL Public (Luxembourg) (Hong Kong)

18.4% 43.4% 27.3%

Goldpac (Hong Kong)

100% 100%

Goldpac Secure-Card Goldpac Datacard (PRC) (Hong Kong)

100%

Goldpac Guangzhou (PRC)

Source: Company Data, Guosen Securities (HK) Research

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Figure 57 Management Team Name Title Brief Mr Lu Run Ting Chairman and Executive Responsible for the overall strategic planning and overseeing Director the general management of the company Prior to establishing the company in 1995, Chairman Lu served as deputy manager at ICBC Zhuhai branch Born in Shanghai with over 20 years of experience in the business of the financial card industry MBA degree from the Hong Kong Polytechnic University Mr Hou Ping Executive Director and CEO Responsible for the overall management of the company Over 30 years of experience in the banking industry and over 14 years of experience in the card industry Joined the firm in 2011; MBA degree from the Hong Kong Baptist University Mr Lu Runyi Executive Director and Primary responsible for the management of the sales Senior Vice President department of the group Over 20 years of experience in the financial cards industry Joined the firm in 1995; He is the younger brother of Chairman Lu Mr Lu Executive Director and senior Responsible for the management of the corporate business, Xiaozhong vice president management, quality, and security department of the group. Joined the firm in 1995; serviced various managerial roles in the company Mr Wu Si Qiang COO Responsible for the production division Joined the firm in 2001 and served various managerial positioned in the company Ms Li Yijin CFO Over 22 years of experience in the accounting and financial reporting matters. Mr Li Jun CTO Responsible for the management of technical solutions department and R&D department. Former engineer in Giesecke&Devrient GmbH

Source: Company Data, Guosen Securities (HK) Research

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Summary Financial Statements (Year to Dec 31)

Profit & Loss (RMBm) FY14A FY15A FY16F FY17F FY18F Financial Ratios FY14A FY15A FY16F FY17F FY18F Revenue 1,521 1,685 1,772 1,875 1,969 Gross profit margin (%) 27.5 26.4 26.5 25.6 25.2 Revenue growth (%) 36.8 10.8 5.2 5.8 5.0 Operating profit margin (%) 15.2 15.6 16.0 15.3 15.0 Cost of sales (1,103) (1,240) (1,303) (1,395) (1,473) Underlying profit margin (%) 16.1 15.4 15.6 15.3 15.2 Gross profit 419 445 469 480 496 Net debt/equity (%) (93.5) (71.8) (84.5) (86.2) (87.9) Other income/(expense) 25 41 43 45 48 Net debt/total assets (%) (65.0) (49.9) (59.0) (60.8) (62.6) Operating expenses (213) (223) (229) (239) (248) Current ratio (%) 303 278 284 294 306 Operating profit 231 263 283 287 296 Dividend payout (%) 34.0 48.2 28.2 28.2 28.3 Operating profit growth (%) 10.0 14.1 7.6 1.2 3.2 Interest cover (x) 218 5,482 Other non-operating inc/(exp) (1) 0 0 0 0 Dividend cover (x) 2.9 2.1 3.6 3.5 3.5 Finance income 28 30 32 42 47 Acct. receivable turnover days 62.1 89.3 89.3 71.0 71.3 Finance expenses (1) 0 0 0 0 Acct. payable turnover days 193.4 203.9 209.6 211.8 213.2 Associates & JCE 0 3 3 3 3 Inventory turnover days 92.2 89.2 92.0 91.1 91.7 Profit before taxation 257 296 318 331 346 Cash cycle days (39.1) (25.4) (28.3) (49.7) (50.3) Taxation (43) (54) (58) (61) (63) Dupont Analysis FY14A FY15A FY16F FY17F FY18F Non-controlling interests 0 0 0 0 0 Tax burden (%) 83.2 81.7 81.7 81.7 81.7 Net profit 214 242 260 270 282 Interest burden (%) 111 113 112 116 117 Other Adjustments on UP 31 17 17 17 17 Operating profit margin (%) 15.2 15.6 16.0 15.3 15.0 Underlying Profit 245 259 277 287 299 Asset turnover (x) 0.7 0.7 0.6 0.6 0.6 Underlying profit growth (%) 42.2 5.8 7.0 3.9 4.1 Leverage ratio (x) 1.4 1.4 1.4 1.4 1.4 EPS (RMB) 0.252 0.287 0.309 0.321 0.335 ROA (%) 10.0 9.8 9.5 9.1 8.8 Underlying EPS (RMB) 0.289 0.307 0.329 0.342 0.355 ROE (%) 14.2 14.1 13.6 12.9 12.4 Underlying EPS growth (%) (3.6) 6.3 7.0 3.9 4.1 Source: Guosen Securities (HK) Research DPS (RMB) 0.10 0.15 0.09 0.10 0.10 DPS growth (%) 0.0 50.8 (37.5) 4.1 4.3 Source: Guosen Securities (HK) Research

Balance Sheet (RMBm) FY14A FY15A FY16F FY17F FY18F Cashflow (RMBm) FY14A FY15A FY16F FY17F FY18F Fixed assets 186 196 201 199 192 Operating profit 231 263 283 287 296 Associates & JCE 0 38 41 44 48 Depreciation & amortization (29) (42) (46) (51) (57) Others 28 233 233 233 233 Interest expense 1 0 0 0 0 Non-current assets 215 467 475 477 473 Change in working capital 46 (184) 210 11 8 Inventories 285 321 336 360 380 Tax paid (44) (27) (58) (61) (63) Debtors & prepayments 312 512 354 375 394 Other operating cashflow 86 90 88 100 111 Bank deposits & cash 125 984 1,368 1,566 1,776 Operating activities 291 100 477 285 294 Others 1,380 322 322 322 322 Purchase of non-current assets (Capex) (89) (23) (50) (50) (50) Current assets 2,102 2,139 2,381 2,623 2,872 Free cash flow 201 77 427 235 244 Bank & other borrowings 0 0 0 0 0 Disposal of non-current assets 0 0 0 0 0 Trade & payables 670 715 782 837 884 Associates & JCE (net) 0 0 0 0 0 Taxation 18 36 36 36 36 Interest received 28 30 32 42 47 Others 5 19 19 19 19 Dividends received 0 0 0 0 0 Current liabilities 693 770 837 892 939 Other investing cashflow (354) 780 0 0 0 Bank & other borrowings 0 0 0 0 0 Investing activities (415) 787 (18) (8) (3) Others 13 23 23 23 23 New loans raised 0 0 0 0 0 Non-current liabilities 13 23 23 23 23 Repayment of loans (86) (5) 0 0 0 Net assets 1,611 1,814 1,996 2,185 2,383 Dividends paid (32) (66) (78) (81) (85) Share capital 1,175 1,190 1,190 1,190 1,190 Other financing cashflow 71 11 3 3 3 Premium & reserves 436 624 806 995 1,192 Financing activities (46) (61) (75) (78) (81) Shareholders' funds 1,611 1,814 1,996 2,185 2,383 Inc/(dec) in cash (171) 827 384 198 209 Non-controlling interests 0 0 0 0 0 Cash at beginning of year 594 423 1,251 1,636 1,834 Total equity 1,611 1,814 1,996 2,185 2,383 Foreign exchange effect 0 1 0 0 0 BVPS (RMB) 1.9 2.2 2.4 2.6 2.8 Cash at end of year 423 1,251 1,636 1,834 2,043 Source: Guosen Securities (HK) Research Source: Guosen Securities (HK) Research

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Notes

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Notes

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Information Disclosures Stock ratings, sector ratings and related definitions

Stock Ratings: Buy: A return potential of 10 % or more relative to overall market within 6 – 12 months. Neutral: A return potential ranging from -10% to 10% relative to overall market within 6 – 12 months. Sell: A negative return of 10% or more relative to overall market within 6 –12 months. Sector Ratings: Overweight: The sector will outperform the overall market by 10% or higher within 6 –12 months. Neutral: The sector performance will range from -10% to 10% relative to overall market within 6 –12 months. Underweight: The sector will underperform the overall market by 10% or lower within 6 – 12 months.

Interest disclosure statement

The analyst is licensed by the Hong Kong Securities and Futures Commission. Neither the analyst nor his/her associates serves as an officer of the listed companies covered in this report and has no financial interests in the companies. Guosen Securities (HK) Brokerage Co., Ltd. and its associated companies (collectively “Guosen Securities (HK)”) has no disclo sable financial interests (including securities holding) or make a market in the securities in respect of the listed companies. Guosen Securities (HK) has no investment banking relationship within the past 12 months, to the listed companies. Guosen Securities (HK) has no individual employed by the listed companies.

Disclaimers

The prices of securities may fluctuate up or down. It may become valueless. It is as likely that losses will be incurred rath er than profit made as a result of buying and selling securities. The content of this report does not represent a recommendation of Guosen Securities (HK) and does not constitute any buying/selling or dealing agreement in relation to the securities mentioned. Guosen Securities (HK) may be seeking or will se ek investment banking or other business (such as [a] placing agent, lead manager, sponsor, underwriter or proprietary trading in such securities) with the listed companies. Individuals of Guosen Securities (HK) may have personal investment interests in the li sted companies. This report is based on information available to the public that we consider reliable, however, the authenticity, accuracy or completeness of such information is not guaranteed by Guosen Securities (HK). This report does not take into account the part icular investment objectives, financial situation or needs of individual clients and does not constitute a personal investment recommendation to anyone. Clients are wholly responsible for any investment decision based on this report. Clients are advise d to consider whether any advice or recommendation contained in this report is suitable for their particular circumstances. This report is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. This report is for distribution only to clients of Guosen Securities (HK). Without Guosen Securities (HK)’s written authorization, any form of quotation, reproduction or transmission to third parties is prohibited, or may be subject to legal action. Such infor mation and opinions contained therein are subject to change and may be amended without any notification. This report is not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any jurisdictio n where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject Guosen Securities (HK) and its group companies to any registration or licensing requirement within such jurisdiction.

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信息披露公司评级、行业评级及相关定义

公司评级买入：我们预计未来 6-12 个月内，个股相对大盘涨幅在 10%以上；中性：我们预计未来 6-12 个月内，个股相对大盘涨幅介于-10%与 10%之间；减持：我们预计未来 6-12 个月内，个股相对大盘跌幅大于 10%。

行业评级超配：我们预计未来 6-12 个月内，行业整体回报高于市场整体水平 10%以上；中性：我们预计未来 6-12 个月内，行业整体回报介于市场整体水平-10%与 10%之间；低配：我们预计未来 6-12 个月内，行业整体回报低于市场整体水平 10%以上。

利益披露声明报告作者为香港证监会持牌人士，分析员本人或其有联系者并未担任本研究报告所评论的上市法团高级管理人员，也未持有其任何财务权益。

本报告中，国信证券（香港）经纪有限公司及其所属关联机构（合称国信证券（香港））并无持有该公司须作出披露的财务权益(包括持股)，在过去 12 个月内与该公司并无投资银行关系，亦无进行该公司有关股份的庄家活动。本公司员工均非该上市公司的雇员。

免责条款证券价格有时可能非常波动。证券价格可升可跌，甚至变成毫无价值。买卖证券未必一定能够赚取利润，反而可能会招致损失。本研究报告内容既不代表国信证券（香港）的推荐意见，也并不构成所涉及的个别股票的买卖或交易要约。国信证券（香港）或其集团公司有可能会与本报告涉及的公司洽谈投资银行业务或其它业务（例如配售代理、牵头经办人、保荐人、包销商或从事自营投资于该股票）。国信证券（香港）不排除其员工有个人投资于本报告内所提及的上市法团。

报告中的资料均来自公开信息，我们力求准确可靠，但对这些信息的正确性、公正性及完整性不做任何保证。本报告没有考虑到个别客户特殊的投资目标、财务状况或需要，并不构成个人投资建议，客户据此投资，责任自负。客户在阅读本研究报告时应考虑报告中的任何意见或建议是否符合其个人特定状况。本报告并不存在招揽或邀约购买或出售任何证券的企图。

本报告仅向特定客户传送，未经国信证券香港书面授权许可，任何人不得引用、转载以及向第三方传播，否则可能将承担法律责任。研究报告所载的资料及意见，如有任何更改，本司将不作另行通知。在一些管辖区域内，针对或意图向该等区域内的市民、居民、个人或实体发布、公布、供其使用或提供获取渠道的行为会违反该区域内所适用的法律或规例或令国信证券（香港）受制于任何注册或领牌规定，则本研究报告不适用于该等管辖区域内的市民、居民或身处该范围内的任何人或实体。

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