26 September 2016 Asia Pacific/Singapore Equity Research Integrated Telecommunication Services

Hong Kong Telecoms Sector Research Analysts COMMENT Varun Ahuja, CFA 65 6212 3017 [email protected] Fundamentals largely stable; be selective

Figure 1: SmarTone's and HTHK's earnings are sensitive to recovery in wholesale handset trading EBITDA (led by iPhone 7 or iPhone 8) 450 40% (HK$ mn) 34.2% HTHK - % contribution of handset 400 34.0% EBITDA to earnings (RHS) 35% 350 SmarTone - % contribution of 30% 300 handset EBITDA to earnings (RHS) 25% 21.4% 21.7% 250 20% 418 16.4% 20.5% 200 387 15% 150 11.5% 10.8% 11.8% 9.2% 100 212 10% 162 154 50 122 250 5% 79 90 122 0 0% FY6/14 FY6/15 FY6/16 FY6/17E FY6/18E iPhone 5s iPhone 6 iPhone 6s iPhone 7 iPhone 8 HTHK handset EBITDA (LHS) SmarTone handset EBITDA (LHS) Source: Company data, Credit Suisse estimates ■ Cellular: Evolved low-end segment to limit growth. Post the initial burst of positive price actions in 2014, the progress on cellular pricing has been disappointing as prices on the higher end segment have remained largely flat over the past 24 months. However, during the same period, the low segment has evolved with the launch of various speed capped plans, limiting the sector's growth potential. We now forecast the sector's service revenue to remain largely flat over the next three years (vs 1.4% CAGR earlier). However, we expect SmarTone and HTHK to grow faster than HKT over the next 2-3 years and hence gain market share. We also expect a recovery in handset EBITDA for the two telcos. ■ BB: Improvement likely with HKBN changing focus. Though HKBN has shifted focus on revenue (from subscribers), the prices on the ground are yet to reflect the change in strategy. Our recent survey shows that prices in various housing segments have largely remained unchanged except that HKBN has stopped bundling LeTV boxes. That said, we believe fundamentals of the BB sector have shown incremental improvement and we expect pricing to move up over the next two to three years. ■ More positive catalysts for SmarTone and HTHK. We believe SmarTone’s and HTHK’s stocks are likely to have more positive catalysts (from improving outlook on wholesale handset segment along with cellular market share gain) over the next 2 years and hence can outperform HKT’s/PCCW’s during the period. We raise our 2016-18E earnings estimates for SmarTone and HTHK by 0-7% and our TPs by 4-5%. We cut our 2016-18E earnings estimates by 2-10% and hence TPs for HKT Trust (by c.8%) and PCCW (by c.12%), given near-term headwinds. We also like HKBN as we believe fundamentals of the BB market are attractive with HKT and HKBN commanding c. 85% of market share. However, we cut our TP for HKBN by c. 4% as we increase our WACC to factor in constant change in management strategy and reduce our FY16-18E earnings estimates by 3-9%.

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

26 September 2016

Focus charts and tables

Figure 2: We expect SmarTone and HTHK to gain Figure 3: Low end segment of cellular market has cellular market share from HKT Trust evolved with launch of various speed capped plans 100% 450 438 (HK$/mth) 14.4% 14.8% 14.7% 14.8% 14.8% 90% 14.9% 400 Low-end speed capped plans Mainstream SIM 80% only plans 25.3% 25.4% 25.7% 25.9% 25.9% 25.9% 350 70% These plans have been launched over 298 300 the last 15-18 months, increasing the 60% range of low end segment. 238 50% 21.1% 250 21.3% 21.4% 21.7% 21.8% 21.9% 208 198 40% 200 178 30% 148 150 128 108 20% 38.9% 38.6% 38.2% 37.7% 37.5% 37.5% 100 88 10% 50 0% Unli 3GB 1GB