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Hong Kong Telecoms Sector Research Analysts COMMENT Varun Ahuja, CFA 65 6212 3017 [email protected] Fundamentals Largely Stable; Be Selective

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Hong Kong Telecoms Sector Research Analysts COMMENT Varun Ahuja, CFA 65 6212 3017 Varun.Ahuja@Credit-Suisse.Com Fundamentals Largely Stable; Be Selective 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 2GB 3GB 5GB 1GB 2.5GB 6GB 10GB 2015 2016E 2017E 2018E 2019E 2020E HKT (including CSLNW) Hutch Tel (HK) SmarTone Others 384Kb/s 21Mb/s 42Mb/s 42Mb/s 42Mb/s 42Mb/s 4G 4G 4G 4G Source: Company data, OFCA, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 4: Broadband prices in various housing segments have largely remained the unchanged in Sep'16 Dec'14 Aug'15 Aug'16 Sep'16 Public Mid-end High-end Public Mid-end High-end Public Mid-end High-end Public Mid-end High-end HKT Housing Housing Housing Housing Housing Housing Housing Housing Housing Housing Housing Housing 200 (Fibre) 168-208 208 138-1682 1382 1382 300 (Fibre) 208 208 298-398 208 328-428 1981 328-428 2082 337 500 (Fibre) 206-246 246 398-498 1682 2081 398-498 1682 2081 398-498 1682 2282 332 1000 (Fibre) 298-338 338 498-598 2062 338 428-598 2062 2461 428-598 2062 2462 477 HKBN 100 (Fibre) 158 173-188 188-298 138-158 208 268 128 178-188 142 128 142 142 500 (Fibre) 178 193-208 208-318 158-168 228 288 158 198 198 158 198 198 1000 (Fibre) 198 213-228 228-338 168-178 228 338 155 178 178 160 188 188 Note 1: Sample prices of residential broadband-only packages in Hong Kong; Note 2: These plans are for 30months contract while the remaining are on 24 months contract.; Note 3: HKBN plans come bundled with broadband, fixed voice, myTV Super box (TVB OTT), and LeTV box; From Sep'16, LeTV box is removed from the bundled.; Note 4: HKT comes bundled with 12months of free mobile SIM offering 6GB data and unlimited voice, starter pack of Now TV and one special pack worth HK$68 free. For fixed voice, subscribers need to HK$46/month for a 30 month contract.; Note 5: There is no installation fees charged by HKBN while HKT charges HK$380, HK$680, and HK$980 installation fees for public, mid-segment and upscale households. However, HKT reimburses majority the installation fees through super mart shopping vouchers.; Note 6: HKBN charges HK$450 for the Wi-Fi router while HKT gives free router for plans with speed less than 500Mbps. HKT charges HK$58/month for 1Gbps plan. ; Source: HKBN global offering prospectus, MPA Dec-14 Survey, Companies' websites, Credit Suisse Figure 5: HK Telcos changes in estimates Rating Target price Year % change in service rev % change in EBITDA % change in earnings % change in dividends New Previous New Previous % chng T T+1 T+2 T+3 T+1 T+2 T+3 T+1 T+2 T+3 T+1 T+2 T+3 SmarTone O O 16.50 16.15 2.2% 06/16 0.2% 1.7% 1.9% 0.5% 3.6% 3.6% 1.6% 7.4% 6.9% 1.7% 4.6% 6.9% HTHK O O 3.25 3.10 4.8% 12/15 0.0% 0.6% 1.1% 0.0% 0.8% 1.1% 0.3% 1.8% 3.3% 0.3% 1.7% 3.3% HKBN O O 11.00 11.50 -4.3% 08/15 -0.9% 1.0% 3.4% -2.6% -4.2% -2.0% -6.3% -9.0% -3.3% 0.0% -2.0% -8.3% HKT Trust N N 11.50 12.45 -7.6% 12/15 -0.4% -1.2% -1.6% -0.7% -1.8% -2.9% -1.7% -2.9% -4.6% -0.5% -3.4% -4.0% PCCW U U 4.55 5.15 -11.7% 12/15 -0.4% -1.1% -1.5% -1.2% -2.8% -4.1% -3.9% -6.8% -9.8% 0.0% -4.1% -6.6% Note: Service revenue and EBITDA for SmarTone, HKT, and PCCW are adjusted for customer acquisition cost amortization; Source: Credit Suisse estimates Figure 6: HK telcos valuation comparison Rat. CP TP % Pot. P/E (x) EV/EBITDA (x) FCF yield (%) Div yield (%) (HK$) (HK$) Up/(dn) 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E SmarTone O 12.68 16.50 30.1% 15.9x 14.9x 14.1x 6.0x 5.6x 5.4x 4.2% 8.4% 8.5% 4.9% 5.2% 5.8% HKBN O 8.90 11.00 23.6% 27.4x 22.4x 18.0x 11.6x 10.4x 9.4x 4.6% 5.1% 6.2% 4.6% 5.1% 6.2% Hutch Tel O 2.66 3.25 22.2% 15.8x 13.9x 13.1x 6.9x 6.4x 6.3x 8.4% 8.4% 10.9% 4.8% 5.4% 6.1% HKT Trust N 10.90 11.50 5.5% 17.1x 17.0x 16.2x 11.8x 11.5x 11.2x 5.2% 5.6% 6.1% 5.2% 5.6% 6.1% PCCW U 4.88 4.55 -6.8% 18.8x 18.2x 17.0x 11.1x 10.7x 10.1x 4.2% 6.2% 6.4% 5.1% 5.4% 5.9% Note: Prices as of 23 September 2016; O = OUTPERFORM; U = UNDERPERFORM, and N = NEUTRAL, Source: Thomson Reuters, Company data, Credit Suisse estimates Hong Kong Telecoms Sector 2 26 September 2016 Fundamentals largely stable; be selective Cellular: Evolved low-end segment to limit growth We expect cellular Post the initial burst of positive price actions in 2014 (after CSL acquisition), the progress sector service revenue on cellular pricing has been disappointing as the prices on the higher end segment have to remain largely flat remained largely flat over the past 24 months.
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