Initiation 10 Feb 2015

TCL Communication Technology Holdings Limited BUY 2618.HK / 2618 HK

China Mobile technology – Mobile devices

HK$7.20* blasting out of Target price: HK$10.30

Upside: 43% We initiate coverage on TCL Comm with a BUY rating and a target price of HK$10.30. The company HSI: 24,521.00 primarily manufactures and sells feature phones, smartphones and tablets in emerging regions such *Closing price as at 9 Feb 2015 as Latin America (LATAM) and Europe, Middle East and Africa (EMEA). We believe TCL Comm will experience strong and sustainable growth due to the following reasons: Share Data 52week Hi/Lo (HK$) 10.96/6.60 ► Strong shipment growth driven by LATAM and EMEA markets – Overseas shipment in Avg. daily t/o (US$m) 3.582 2014 reached 65.9m units, up 30.8% from 2013. Given low penetration rates of mobile devices Market Cap. (US$m) 1,137 in LATAM and EMEA, we believe shipments in the aforesaid regions are expected to attain over Total issued shares (m) 1,224 20% CAGR for the next 3 years. Auditor E&Y Public float (%) 33.95% ► Migration to smartphones in key markets boost ASP – Currently, around 65% of shipments Major shareholder: are shipments. ASP of smartphones can reach US$80 compared to ~US$15 for TCL Corporation 60.07% feature phones. We expect migration to smartphones will be the key growth driver in the next 2 Value Partners 5.98% years and up-trading will fuel subsequent growth. Source: HKEx & Bloomberg ► Superior margins compared to Chinese peers – TCL Comm consistently achieves a GPM of

~19% for the past 7 quarters. Compared to Chinese peers like and ’s ~13% GPM for the past year, TCL Comm has done a terrific job maintaining its GPM cutting costs, Company Profile strategically control customers’ spec expectations and exploring markets willing to pay higher TCL Comm manufactures and sells prices, i.e. the Americas. Our channel checks reveal that its ASP for smartphones is among the mobile devices and internet products. lowest in China and India; and highest in North America. The company sells to over 120 countries worldwide including China, the Americas and EMEA. ► TP=HK$10.30, based on 10x 2015E P/E – We expect the company to generate a revenue of 14000 HK$30.2b/39.4b/51.3b in 2014/15/16 respectively. Net profit for the next 3 years is expected to 12000 be HK$933m/HK$1.24b/HK$1.58b. Our TP is based on 10x 2015E P/E, which is near TCL Share Price Chart 10000 Comm’s historical mean and current peer levels. 8000 Installed ► Downside risks – 1) Price war with other smartphone brands. 2) Slower than expected network 6000 Capacity rollouts by carriers. 3) Geopolitical events. 4) Capital controls and FX swings. 4000 (MW) 2000 0 2005 2007 2009 2011 2013

Source: Bloomberg

Earnings Forecasts & Valuation Summary Year ended 31 Dec 2012A 2013A 2014E 2015E 2016E Sales (HK$’m) 12,031 19,362 30,281 39,406 51,331 EBITDA (HK$’m) (72) 484 2,090 2,881 3,713 Net profit (HK$’m) (208) 313 933 1,236 1,575 EPS - Fully diluted (HK$ ) (0.185) 0.266 0.738 1.030 1.313 YoY change (%) N/A N/A 177.7 32.6 27.4

PER (x) 26.9 49.4 9.3 6.8 5.3 DPS (HK$) * N/A N/A 0.155 0.206 0.263 Yield (%) N/A N/A 2.1 3.0 3.8 Phelix Lee ROE (%) -9.0 12.9 24.5 25.5 25.5 (852) 2283 7618 Net debt/equity (%) 218.3 113.2 130.8 107.6 64.7 [email protected] Source: Company data, Sunwah Kingsway Research estimates www.kingswayresearch.com

Kingsway Financial Services Group Limited Please see the important disclaimer and disclosures (if any) at the end of this report

Valuation We initiate coverage on TCL Comm with a “BUY” rating at a target price of HK$10.30. Our TP implies a 10x 2015E P/E. We use P/E as our valuation basis. The company has effectively only ONE operating segment, which is the manufacture and sale of mobile devices. We derive our P/E of 10x 2015E P/E from the following factors: 1) Strong volume growth prospects due to above-peer exposure to LATAM and EMEA regions; 2) ASP are rising due to smartphones beginning to replace feature phones in emerging markets; 3) upside potential in the Palm acquisition leading to North American shipment growth; 4) increasing availability of 3G and 4G connectivity in LATAM and EMEA, which may lead consumers to demand more higher-price 3G/4G handsets.

Valuation comparison The closest peers of TCL Comm are Coolpad and HTC, which have their own brand(s), manufacture mobile devices and related accessories. Other major peers include , LG Electronics, Apple who produce mobile devices and other .

Peer Valuation Table

Source：Bloomberg, closing price @, 9 Feb 2015 Sunwah Kingsway Research

TCL Communication | 10 Feb 2015 2

Company description The only smartphone maker in China with 2-end strategy TCL Comm manufactures and sells mobile devices and internet products. The company sells to over 120 countries worldwide including China, the Americas and EMEA. The company sells mobile devices by leveraging its parent company’s ‘TCL’ brand in China and ‘Alcatel’ brand overseas (including Hong Kong). In 4Q14 alone, TCL Corporation has acquired an additional 42.85m shares or 5.97% of TCL Comm at an average price of HK$7.55 per share.

Shareholder structure

Source: HKEx, Company data

Company milestones

Year Milestone  TCL Comm was established as the holding company of Huizhou TCL Mobile 2004  Listed on HKEx  Established Alcatel Mobile via a 55% JV with Alcatel Lucent  Acquired the remaining 45% stake from Alcatel Lucent, Alcatel Mobile became wholly-owned subsidiary 2005 of TCL Comm  Announced new strategy called “The Creative Life”  Re-launched Alcatel brand in China 2007  Extended Alcatel brand license to 2024  Cooperated with RIM Company (now Blackberry Ltd.) to introduce Blackberry 8700 to China 2008  T-Mobile became a customer of TCL Comm  Launched first 3G Android smartphone 2010  Named ‘fastest growing major mobile vendor in the world’ by Strategy Analytics and exceeded 4m monthly shipment in November  Opened Chengdu R&D centre 2011  Manufactured for the Vodafone 555 Blue, first handset with Facebook pre-installed  Launched first tablet, i.e. the TCL Pad16/Alcatel One Touch T60 2012  Launched liquid repellent smartphones –TCLS800 and TCLS600  Launched the slimmest smartphone at the time, i.e. TCLS850/Alcatel One Touch Idol Ultra at 6.45mm  Commenced production of new manufacturing facility in Huizhou 2013  Partnered with Hong Kong Applied Science and Technology Research Institute to develop 4G applications and research 5G wireless technology  TCL Corporation, TCL Comm and TCL Multimedia (1070 HK) formed JV for smart home initiative 2014  Partnered with Cisco to set up Enterprise Cloud Services Platform 2015  TCL Comm acquired ‘Palm’ brand from Hewlett-Packard, Inc. Source：Company data

TCL Communication | 10 Feb 2015 3

Industry Overview 3G/4G network overview

Emerging regions including Sub-Saharan Africa (SSA), Latin America (LATAM) and Middle East and North Africa (MENA) represent huge growth opportunities for TCL Comm due to their low smartphone penetration, rising income levels and increasingly available 3G/4G network services offered by national and regional carriers. The following tables summarize carrier availability of 3G/4G services of LATAM, Africa and Middle East respectively. LATAM 3G/4G carrier availability summary

Source: Carriers, Census data, Sunwah Kingsway Research

As of early Jan 2015, out of the 44 countries/regions in LATAM, only 4 nations have to provide 3G/4G connection, representing just about 1% of total population of the continent. There are 21 countries offering 4G services at the moment and 12 more planning to do so within the next 2-3 years. We believe carriers have incentives to promote low-end smartphones in order to increase their own revenues via data tariff and other value-added services. In turn, TCL Comm will benefit immensely from its good relations with carriers in the region, and sell many more low-end smartphones.

LATAM sales account for 51.5% of TCL Comm’s revenue for 9M14. At the moment, TCL Comm has working relationships with América Móvil, which in turns owns major carriers like Claro, TelCel and TelMex; as well as Telefónica, Tigo and Digicel. The four major telecom companies are estimated to have over 80% market share in LATAM, which translates into a formidable distribution channel for TCL Comm. Africa 3G/4G carrier availability summary

Source: Carriers, Census data, Sunwah Kingsway Research

Middle East 3G/4G carrier availability summary

Source: Carriers, Census data, Sunwah Kingsway Research

TCL Communication | 10 Feb 2015 4

For Middle East and Africa (including SSA and MENA), out of the 70 countries, only 27 has a carrier providing 4G services, but widening the scope to 3G services, the figure jumps to 51. With 18 countries planning 4G services, we believe carriers will replicate their LATAM peers and bundle low-end smartphones with 3G/4G data plans. A caveat is that Middle Eastern and African countries on average are less stable than other parts of the world, which may significantly delay network development and user adoption. The company generates roughly 10-15% 9M14 sales from Middle East and Africa. TCL Comm has partnerships with major carriers like MTN, Orange, Airtel, Vodafone and Telefónica in Middle East and Africa; which constituted an estimated 60% market share in the region. Again, this shows TCL Comm is facing a growing market and has the necessary distribution channels to capture the opportunity. Smartphone penetration overview SSA and LATAM are regions with lowest smartphone penetration in the world. The below table summarizes current and projected figures of SSA users and mobile penetration rates. SSA mobile user & penetration summary 2013-2018F

Source: GSM Association, Sunwah Kingsway Research estimates Country-wise, more affluent nations such as Mauritius, Seychelles and South Africa have higher mobile penetration rates averaging over 70%; as opposed to world’s poorest nations like Burundi, Niger and war-torn Central African Republic averaging less than 25% in 2013. We believe current low adoption rates, rising income and high youth population could propel smartphone growth in the continent, giving plenty of growth space for TCL Comm and other smartphone makers.

In terms of market size, we assume the replacement cycle of SSA phones to be 2.5 years. Using GSM Association’s numbers, we estimate the addressable market of TCL Comm for the next few years as follows: SSA mobile phone market size estimates 2014F-2018F

Source: GSM Association, Sunwah Kingsway Research estimates

The addressable market in SSA for TCL Comm is estimated to be about HK$88.3b/101b/120b for 2015/16/17 respectively. If TCL Comm can maintain an estimated 6% market share in these regions, it may generate revenue of HK$5.30b/6.08b/7.20b in the region for 2015-2017, representing 17.3% 3-year CAGR from 2014’s estimated HK$4.46b. By these projections, the region will contribute 13.4%/11.8%/11.0% of TCL Comm’s revenue from 2015-17.

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The below table summarizes mobile user numbers and penetration in LATAM. LATAM mobile user & penetration summary 2013-2018F

Source: GSM Association, Sunwah Kingsway Research estimates

Although Brazil leads the way in terms of unique subscribers due to its large populace, the nation ranked only 2nd in the region in smartphone adoption rates at 32.4% in 3Q14, falling behind Venezuela’s 45.1%. The continent’s overall smartphone adoption rate is about 28.6% as of 3Q14, and is projected to reach 59% (496m units) by the end of 2018 and 68% by the end of 2020. We believe 283m units of new smartphone demand will bring about HK$170b sales from 2015-2018.

Again we estimate TCL Comm’s addressable market in LATAM using a similar approach as SSA. The table below shows estimates of the LATAM market. LATAM mobile phone market size estimates 2014F-2018F

Source: GSM Association, Sunwah Kingsway Research estimates

The addressable market in LATAM for TCL Comm is estimated at HK$112b/129b/152b for 2015/16/17 respectively. From TCL Comm’s shipment figures and GSM’s industry predictions, we estimate TCL Comm’s has 17% market share in LATAM’s mobile market. If TCL Comm can grow to 22% market share by 2017, it may generate revenue of HK$20.4b/26.7b/34.0b in the region for 2015-2017, representing a 29.7% 3-year CAGR from 2014’s estimated HK$15.6b. By these projections, the region will contribute 51.8%/52.0%/52.2% of TCL Comm’s revenue from 2015-17.

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Moreover, Middle East and North Africa (MENA) is also experiencing strong growth. GSM Association estimates 3-year CAGR to reach 14.5% from 2015-2017. The below table summarizes current and projected figures of MENA mobile phone and mobile penetration rates. MENA mobile user & penetration summary 2013-2018F

Source: GSM Association, Sunwah Kingsway Research estimates

We replicate our market size estimate approaches as in SSA and LATAM. We estimate the addressable market of TCL Comm for the next few years as follows: MENA mobile phone market size estimates 2014F-2018F

Source: GSM Association, Sunwah Kingsway Research estimates The addressable market in MENA for TCL Comm is estimated at HK$65.8b/74.0b/84.4b for 2015/16/17 respectively. If TCL Comm can maintain its estimated 6% market share until 2017, it may generate a revenue of HK$4.25b/5.41b/6.76b from this region for 2015-2017, representing a 22.1% 3-year CAGR from 2014’s estimated HK$3.71b. By these projections, the region will contribute 10.9%/10.5%/10.4% of TCL Comm’s revenue from 2015-17.

Competition intense globally, even more so in China The competitive landscape of the smartphone market is intense since 2010. TCL Comm faces fierce competition in all regions. We outline TCL Comm’s primary competitors in different geographic regions in the following table.

China APAC ex China North LATAM Europe Middle East

America & Africa

1st Samsung Apple Samsung

2nd Samsung Lenovo Samsung Lenovo Apple

rd 3 Lenovo Micromax LG Huawei Lenovo

4th Huawei Karbonn Lenovo ZTE

5th Coolpad Smartfren HTC LG

Source: Companies, Sunwah Kingsway Research To add, APAC market is relatively fragmented with numerous homegrown brands. Examples are Micromax and Karbonn in India, Smartfren in , Q Mobile in Pakistan, Ninetology in , I-Mobile in and Cherry Mobile in the . TCL Communication | 10 Feb 2015 7

Business Overview

Non-China focus handset play According to Gartner, mobile phone sales were essentially flat in 3Q14 compared to 3Q13, standing at about 456m units. During the period, EMEA excluding Western Europe achieved over 50% YoY increase, while the US achieved 18.9% growth and Western Europe shipments declined by 5.2%. Gartner’s claims were supported by TCL Comm’s numbers. For TCL Comm, mobile phone shipments for 9M14 in the Americas and EMEA grew 46% and 27% YoY respectively, far lower than contemporary smartphone growth figures of 295% and 122% respectively. TCL Comm’s mobile shipment numbers since 1Q13

Source: Company, Sunwah Kingsway Research

TCL Comm’s smartphone shipment numbers since 1Q13 (exc. 4Q13)

Source: Company, Sunwah Kingsway Research estimates

TCL Communication | 10 Feb 2015 8

ASP supported by migration to smartphones TCL Comm’s top-line growth does not only come from shipment growth, but also ASP improvements through smartphone replacing feature phone as their source of revenue. The company generated 86.9% of its revenue or HK$6.76b from smart devices, primarily smartphones in 3Q14, as compared to 49.5% in 1Q13. The following chart shows the revenue contribution and sales figures by smart devices since 1Q13. Smart device revenue data since 1Q13

Source: Company, Sunwah Kingsway Research

Although ASP for smart devices came down from HK$834 in 1Q13 to HK$621 in 3Q14, blended ASP increased from HK$289 to HK$417 in the same period thanks to smartphone shipment proportion grew from 17% in 1Q13 to 58% in 3Q2014. For reference, smartphone shipment proportion of TCL Comm exceeded 63% as of Dec 2014. The following charts show the trend of smartphone shipment proportion and ASP of TCL Comm. ASP and smartphone shipment proportion trend since 1Q13

Source: Company, Sunwah Kingsway Research

TCL Communication | 10 Feb 2015 9

ASP trends since 1Q13

Source: Company, Sunwah Kingsway Research estimates Looking forward, we believe smartphone ASP will find strong support at current levels in 2015 and 2016. TCL Comm’s 1H14 blended ASP stood at ~HK$408. However, we opine that there is more upside in TCL Comm’s blended ASP as the company is still achieving 35% non-smartphone shipment ratio. The blended ASP can further increase in case more emerging region carriers, especially in LATAM and EMEA introduce 3G/4G services and consumers who are gradually more affluent are convinced of the benefits of 3G/4G smartphones. Beyond 2016, we believe smartphone upgrades will drive both top-line growth and GPM improvement. At the moment, smartphone ASP is dropping because growth is focused on low/mid-tier smartphones in LATAM and EMEA, as well as intense competition in APAC such as against Xiaomi in China and Micromax in India. We base our belief of EMEA and LATAM to outgrow other region because of their proven GDP growth from 2009 to 2013, according to World Bank, low and middle income countries grew by 5.32% per year on average as opposed to the world average of 1.86% and high income region average of 0.82%.

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Undercutting giants with competitive products TCL Comm offers aesthetic and competitive products at attractive prices, usually undercutting giants like Samsung. Below is a comparison of TCL Comm’s Alcatel Hero 2 versus Samsung’s Galaxy A7

Alcatel Hero 2 Samsung A7

Source: Companies, Sunwah Kingsway Research estimates

We view TCL Comm’s offering to be more competitive although Samsung’s A7 weighs less, possesses a more powerful chipset and a more up-do-date OS because the Hero 2 offers a larger screen, superior camera, sells for a lower price and the fact the handset was released nearly 2 quarters ahead the Samsung A7. We believe if TCL Comm can continue to offer value-for-money handsets swiftly, it could eventually steal market share from Samsung and other global giants.

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Unparalleled carrier distribution channels TCL Comm has distribution agreements with major LATAM telecom companies such as Claro, Telcel, Digicel and Tigo; as well as AT&T and T Mobile in the US; Vodafone, Telefonica, MTN and Orange in EMEA; and all 3 major carriers in China, forming a far-reaching distribution network globally. A caveat is that TCL Comm is relatively weak in APAC, with most distribution channels situated in Hong Kong. The illustration below shows the approximate geographic distribution of TCL Comm’s partner carriers globally.

Source: Company, Sunwah Kingsway Research

Faster-than-peers product cycle TCL Comm positions itself as “fast fashion follower” similar to Zara and H&M in the apparel market. It tends to focus on quick to market products at an affordable price to leverage its close working relationship with local mobile operators. The company expects on average a 9-month product life cycle compared to 12-18 months for leading international brands, which allows TCL Comm to respond quickly to changing demands and tastes of operators and consumers. TCL Comm’s positioning strategy relative to fashion brands

Source: Company, Sunwah Kingsway Research

TCL Communication | 10 Feb 2015 12

Financial analysis Revenue posed to grow 38.4% CAGR from 2014-16

TCL Comm attained revenue of HK$19.4b revenue in 2013; we estimate 2014-16 revenues to be approximately HK$30.3b/39.4b/51.3b respectively driven by both ASP improvement and shipment growth. We project shipment growth to be 35%/30% in 2015 and 2016 from 2014’s 73.5m units. Our blended ASP assumption is HK$412.1/461.6/491.3 for 2014-16 respectively; relevant assumptions are listed in the table below. Assumption table

Source：Company data, Sunwah Kingsway Research estimates

Revenue breakdown

Source：Company data, Sunwah Kingsway Research estimates

ASP trend projections 2014-2016

Source: Company, Sunwah Kingsway Research We model TCL Comm’s smartphone and non-smartphone ASP at a moderate decline due to 1) intensifying competitive landscape in China as the company expressed its intention to focus more on China in 2015 and beyond to pursue smart home integration strategy together with TCL Corp; 2) carrier competition in EMEA and LATAM lead to demands for deeper subsidies in handset sales; 3) very low-end smartphones (at ~US$50 retail price range) dominating emerging market smartphone growth.

Nonetheless, we believe the fall in individual ASP will not harm blended ASP due to smartphone migration. We estimate smartphone shipment ratio for TCL Comm to be 68% and 75% in 2015 and 2016 respectively. Smartphone adoption is stimulated by recent availability in 4G networks in LATAM and EMEA. For example, Argentina has only its first 4G network offered by Movistar (owned by Telefónica) and Personal (owned by Telecom Argentina) as recent as December 2014. Carriers in Kenya and Ghana offered 4G services in 2014. We believe it takes at least 3 years, as in the case of China in order to have 4G services match the prevalence of 3G users, which could to a certain extent, secure growth potential for TCL Comm.

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GPM stable at 18-19% by FY16 Gross profit margin of TCL Comm stabilized at around 19% from 1Q13 onwards. TCL Comm’s 19.6% trailing 12 months GPM is superior to Coolpad’s 13.2% and comparable to HTC’s 21.1%. However, HTC is more exposed in the mid/high-end smartphone markets, which lead us to estimate that TCL Comm has the best GPM in mid/low-end smartphones. Our gross profit forecasts for 2014-16 are HK$5.80b/7.45b/9.65b respectively. GPM is forecasted at 19.1%/18.9%/18.8% for 2014-16 respectively. The graph below shows our estimates for gross profit and GPM. Gross profit and gross profit margin estimates

Source：Company data, Sunwah Kingsway Research estimates

We believe TCL Comm can maintain its GPM at our forecasted levels for the next 3 years due to the following reasons:

1) Exploiting production automation to reduce unit costs. An increase in volume enables the company capture economies of scale in form of lower depreciation, amortization, direct labor and factory overheads per unit sold. We believe TCL Comm’s efforts can also mitigate the effects of minimum wage hikes in the foreseeable future.

2) Marketing itself as a fast fashion brand like Zara and H&M in the apparel sector. This differentiates Alcatel’s phones from other smartphone brands like Lenovo and Huawei which relies on top-notch hardware to win customers. The company emphasizes on design factor in order to justify a slight premium to appeal to fashion wannabes. Its fast product cycle adds to the company’s ability of responding to different fashion tastes in various locales.

3) Leveraging the newly acquired ‘Palm’ brand to strengthen foothold in North America by offering mid/high-end phones. Mid/high-end products command higher margins due to customer demand and technology sophistication. With its incumbent relationships with AT&T, Sprint and T-Mobile, the company can distribute its new brand to quickly tap the market.

4) Retaining customers through its 2 JVs. The first JV with other TCL group companies aims to keep customers sticky by offering smart home solutions. The second JV with Cisco aims to attract corporate users with teleconferencing infrastructure. We believe this differentiates TCL Comm’s smartphone offering from its competitors and possibly command a higher margin than peers.

TCL Communication | 10 Feb 2015 14

Scale economies to drive up net margin We foresee TCL Comm to maintain stringent cost control in operating expenses in 2014-16, and lower its OPEX to revenue ratio will drop from 2013’s 19.5% to 2016’s 16.1%.

We identify the main reason for OPEX to revenue ratio drop to be scale economies from increased in handset shipments. R&D is correlated to quantity, expected product life cycle and technical sophistication of new products instead of shipments. The amount of SG&A expenses depends on geographic reach, customers’ concentration and company network. Net profit and Net profit margin estimates

Source：Company data, Sunwah Kingsway Research Estimates

We expect TCL Comm to record net profit of HK$932m/1.24b/1.58b for 2014-2016 respectively. With largely stable GPM and lower OPEX ratio to revenue, we expect NPM to be 3.1% for all 3 years. Net profit and Net profit margin estimates

Source：Company data, Sunwah Kingsway Research Estimates

TCL Communication | 10 Feb 2015 15

Financial position TCL Comm retains a net debt of nearly HK$1b as of 30 Sept 2014, representing net debt to equity ratio of 26.1%. We estimate with the increase of revenue brought by higher ASP and shipment volumes. Operating cash flow is expected to increase to HK$1.41b/3.68b in 2015 and 2016, which we believe is sufficient to finance its HK$4-5b CAPEX needs for these 2 years. TCL Comm can also factor more of its receivables at the expense of profitability in case of dire liquidity needs.

Cash conversion cycle TCL Comm’s inventory turnover days is expected to increase to around 60-65 days due to more inventories needed to prepare for larger shipments. Besides, smartphone adoption will drive the value of year-end inventory higher, especially when more smartphones are shipped in 2H of each calendar year. The AR turnover days fell from 80 days in 2012 to 73 days in 2013. We expect receivables turnover to fluctuate between 70-80 days depending on carrier agreements, amount of receivables being factored by TCL Comm in accordance to geopolitical situations in its primary markets, as well as its own business and liquidity needs. We consider the company’s AR days is reasonable as it lies in the 90 days credit range normal to industry. Our 2014-2016 cash conversion cycle estimate is around 56-63 days. We believe after ramping up demand in LATAM and EMEA will allow the company to shorten cash conversion cycle by better expecting models and quantity demanded in respective markets. We believe the company has sufficient working capital to cover its short-term liquidity needs.

Year 2012A 2013A 2014E 2015E 2016E AR T/O (days) 82 79 75 77 72 AP T/O (days) 80 73 76 76 76 Inventory T/O (days) 41 46 64 62 60 Cash Conversion cycle (days) 43 51 63 63 56 Source：Company data, Sunwah Kingsway Research Estimates

TCL Communication | 10 Feb 2015 16

Management profile

Director Description  Founding CEO of TCL Corporation (000100 CH)  Over 30 years experience in consumer electronics industry Mr. LI Dongsheng th th  Delegate of 16 Party Congress, representative of 10-12 National People’s Congress (Chairman and Executive  Independent Non-Executive Director of Holdings Limited, Non-Executive Director of Fantasia Director) Holdings Group, Independent Director of Legrand  Graduated from South China University of Technology  Senior Vice President of TCL Corp Mr. GUO Aiping  Previously worked at IBM, Arthur Andersen and Zhaodaola Internet Company (CEO and Executive  Holds Doctor’s degree in Management Science and Master’s degree in Engineering Economics and Director) System from Stanford University  Vice President of TCL Corp Mr. WANG Jiyang  Over 20 years of experience in electronics industry (COO and Executive  Graduated with a PhD in Electrocircuit & System from University of Electronic Science and Technology Director) of China and an MBA degree from China Europe International Business School.  CFO of TCL Corp Mr. HUANG Xubin  Previously worked at China Construction Bank, Guotai Junan Securities, China Cinda Asset (Non-executive Director) Management  Holds an EMBA degree from China Europe International Business School.  Chief Technology Officer of TCL Corp, Executive Director of TCL Multimedia (1070 HK) Mr. YAN Xiaolin  Chairman of China 3D Industry Association (Non-executive Director)  Graduated from the Institute of Plasma Physics of Chinese Academy of Science with Doctoral Degree and worked as post-doctoral fellow in the Chinese Academy of Science  Vice President and HR Director of TCL Corp, Executive Director of TCL Multimedia  Part-time lecturer at Graduate School of Peking University, a distinguished professor at Ms. XU Fang Shantou University and a distinguished research fellow at Sun Yat-Sen University (Non-executive Director)  Graduated from Nanjing Normal University in English Linguistics, and an MBA from New York Institute of Technology  Over 30 years of experience in corporate finance, financial advisory and management, accounting and Mr. LAU Siu Ki auditing (Independent Non-executive  Independent Non-Executive Director of COL Capital Limited, Comba Telecom Systems Holdings Director) Limited, FIH Mobile Limited, Samson Holding Limited, Embry Holdings Limited and Binhai Investment Company Limited  Over 20 years of experience in equity investment analysis of Hong Kong and China stock markets Mr. LOOK Andrew  Chief Investment Officer and Managing Director of Look’s Asset Management Limited (Independent Non-executive  Independent Non-Executive Director of Ka Shui International Holdings Limited Director)  Holds a Bachelor of Commerce degree from the University of Toronto  Chair Professor of the Hong Kong University of Science and Technology Prof. KWOK Hoi Sing  Fellow of the Optical Society of America, Institute of Electrical and Electronics Engineers and SID (Independent Non-executive  Holds Bachelor of Science degree in Electrical Engineering from Northwestern University in the US and Director) MSc and PhD degrees in Applied Physics from Harvard University Source：Company data

TCL Communication | 10 Feb 2015 17

Risk factors Price war with other smartphone brands – The company relies on volume growth to drive its revenue and profits. If other major players expand their LATAM and EMEA foothold by lowering prices aggressively, TCL Comm may be forced to follow suit despite its production differentiation attempts. Slower-than-expected 3G/4G rollout in emerging regions – While carriers in various developing countries have plans to rollout 3G/4G services within the next 2 years, bureaucracy, business concerns and geopolitical events may materially delay network rollouts. Such delays would lead to substantial misses in our forecasted revenues and shipments. Geopolitical risks – Wars, terrorism, coups and other geopolitical events may severely impair the ability of TCL Comm’s ability to collect receivables. The issue is especially pronounced in the West and Central Africa where warlords pose a constant threat. Capital controls in LATAM – Tightening or re-introduction of capital controls will hurt TCL Comm’s ability to collect receivables and/or expatriate profits. Brazil introduced a foreign investment tax in 2009 and cancelled the policy in 2013. Venezuela currently requires an importer to apply for USD in order to pay for purchases through CENCOEX (National Center for Exterior Commerce). Argentina denied residents to buy USD for saving purposes until Jan 2014.

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Financial Statements TCL Comm (2618)

Year ended 31 Dec 2012 2013 2014F 2015F 2016F Year ended 31 Dec 2012 2013 2014F 2015F 2016F Income Statement (HK$m) Ratios Turnover 12,031 19,362 30,281 39,406 51,331 Gross margin (%) 21.4 19.0 19.1 18.9 18.8 YoY% 8.3 60.9 56.4 30.1 30.3 Operating margin (%) -0.2 2.1 4.0 4.1 3.9 COGS (9,935) (15,690) (24,485) (31,958) (41,681) Net margin (%) 8.8 1.6 3.1 3.1 3.1 Gross profit 2,097 3,672 5,796 7,448 9,650 Selling & dist'n exp/Sales (%) 2.4 8.3 8.1 7.8 7.8 Gross margin 21.40% 18.97% 19.14% 18.90% 18.80% Admin exp/Sales (%) 6.2 4.9 4.2 4.1 4.0 Other income 543 513 544 576 611 Payout ratio (%) 31.4 28.3 19.7 19.7 19.7 R&D (740) (1,064) (1,211) (1,497) (1,899) Effective tax (%) 16.8 6.0 18.0 18.1 18.0 Selling & distribution (1,154) (1,611) (2,453) (3,074) (4,004) Admin (658) (946) (1,272) (1,616) (2,053) Total debt/equity (%) 260.1 119.0 144.5 123.6 80.9 Other opex (109) (158) (182) (236) (308) Net debt/equity (%) 218.3 113.2 130.8 107.6 64.7 Total opex (2,117) (3,267) (4,574) (5,847) (7,654) Current ratio (x) 1.1 1.0 1.0 1.1 1.1 Operating profit (EBIT) (21) 405 1,222 1,601 1,997 Quick ratio (x) 0.9 0.8 0.7 0.8 0.7 Operating margin -0.17% 2.09% 4.03% 4.06% 3.89% Provisions 0 0 0 0 0 Inventory T/O (days) 41 46 64 62 60 Finance costs (166) (105) (83) (90) (75) AR T/O (days) 82 79 75 77 72 Profit after financing costs (187) 300 1,139 1,511 1,922 AP T/O (days) 80 73 76 76 76 Associated companies & JVs (2) (2) 0 1 0 Cash conversion cycle (days) 43 51 63 63 56 Pre-tax profit (188) 298 1,139 1,512 1,922 Tax (32) 18 (206) (274) (345) Asset turnover (x) 0.90 1.34 1.41 1.65 1.78 Minority interests (12) 3 1 1 2 Financial leverage (x) 5.74 5.95 5.66 4.92 4.66 Net profit (208) 313 933 1,236 1,575 EBIT margin (%) -0.2 2.1 4.0 4.1 3.9 YoY% 19.8 (250.8) 197.6 32.6 27.4 Interest burden (x) N/A 0.74 0.93 0.94 0.96 Net margin -1.73% 1.62% 3.08% 3.14% 3.07% Tax burden (x) 1.10 1.05 0.82 0.82 0.82 EBITDA (72) 484 2,090 2,881 3,713 Return on equity (%) -9.0% 12.9% 24.5% 25.5% 25.5% EBITDA margin -0.60% 2.50% 6.90% 7.31% 7.23% ROIC (%) -13.2% 8.0% 21.6% 23.0% 23.7% EPS (HK Cents) -18.5 27.5 77.7 103.0 131.3 YoY% 21.1 -248.7 182.7 32.6 27.4 DPS (HK Cents) 3.0 10.0 15.3 20.3 25.8

Year ended 31 Dec 2012 2013 2014F 2015F 2016F Year ended 31 Dec 2012 2013 2014F 2015F 2016F Cash Flow (HK$m) Balance Sheet (HK$m) EBITDA (72) 484 2,090 2,881 3,713 Fixed assets 774 1,070 1,574 1,539 1,509 Chg in w orking cap (102) (762) (7) 832 1,134 Intangible assets 1,174 1,210 1,469 1,469 1,469 Others 730 1,301 (1,333) (1,865) (646) Associated companies & JVs 4 5 8 8 8 Operating cash 556 1,023 750 1,848 4,201 Long-term investments 131 195 217 217 217 Interests paid (52) (16) (105) (83) (90) Other non-current assets 26 77 204 204 204 Interests income (213) (113) (67) (78) (86) Non-current assets 2,109 2,557 3,472 3,436 3,406 Tax (177) (119) (206) (274) (345) Net cash from operations 113 775 372 1,413 3,680 Inventories 1,263 2,649 5,937 4,920 8,784 AR 2,842 5,551 6,893 9,733 10,519 Capex + Investments (1,290) (1,543) (3,566) (2,008) (2,508) Prepayments & deposits 1,246 1,151 1,482 1,482 1,482 Interest + Dividends received 210 196 195 195 195 Pledged deposits 4,221 1,698 1,758 1,758 1,758 Change of non-cash equiv. deposits 1 0 0 0 0 Other current assets 669 675 1,458 1,774 1,861 Sales of assets 30 85 85 84 84 Cash 970 142 523 777 1,001 Investing cash (1,050) (1,263) (3,286) (1,728) (2,228) Current assets 11,212 11,866 18,052 20,442 25,404 AP 2,429 3,875 6,322 6,987 10,371 FCF (937) (488) (2914) (315) 1451 Tax 1 13 16 16 16 Issue of shares 26 78 161 0 0 Accruals & other payables 1,620 3,148 3,781 3,462 4,406 Buy-back 0 0 0 0 0 Bank loans 5,726 2,690 5,500 6,000 5,000 Minority interests 9 0 0 0 0 Factored advances 432 485 766 1,081 1,169 Dividends paid (202) 0 (187) (247) (315) Derivatives 96 92 38 38 38 Net change in bank loans (1,302) (3,519) 3,099 500 (1,000) Other current liabilities 301 1,403 1,094 1,238 1,426 Others 2,109 3,211 222 315 87 Current liabilities 10,606 11,706 17,517 18,822 22,425 Financing cash 640 (230) 3,295 568 (1,228) Bank loans 194 196 0 0 0 381 253 224 Other loans/financing 116 0 0 0 0 Net change in cash (217) (828) 381 253 224 Deferred tax 77 85 94 94 94 Adj 0 0 0 0 0 Other non-current liabilities 6 8 8 8 8 Opening cash 1,187 970 142 523 777 MI 2 4 100 100 100 Closing cash 970 142 523 777 1001 Non-current liabilities 394 293 201 201 201 CFPS (HK$) (0.193) (0.736) 0.318 0.211 0.187 Net assets/Net Equity 2,321 2,425 3,805 4,855 6,183 Share capital 1,128 1,162 1,221 1,221 1,221 Reserves 1,193 1,747 2,584 3,634 4,963

Book NAV (HK$) 4,642 5,334 7,610 9,710 12,367 Total debts 6,036 2,886 5,500 6,000 5,000 Net cash/(debts) (5,067) (2,744) (4,977) (5,223) (3,999) Source: Company, Sunwah Kingsway Research Estimates

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Disclaimer

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