Asia Pacific Equity Research 15 September 2013
Initiation Overweight PCCW Limited 0008.HK, 8 HK Growth businesses coming into the limelight; Initiate Price: HK$3.31 with OW Price Target: HK$4.10
We initiate coverage of PCCW with an OW rating and a Dec-14 PT of HK$4.1 Hong Kong which implies 24% share price potential upside plus a 5.9% 2014E yield. We Telecoms think a re-rating is deserved based on its: 1) strengthening pay-TV leadership Michelle Wei, CFA AC driven by the exclusive broadcasting rights of the Barclays Premier League (BPL) (852) 2800-8562 and 2) the rising growth profile of its Solutions business, both organically and [email protected] inorganically. PCCW provides an attractive combination of 9% EPS CAGR J.P. Morgan Securities (Asia Pacific) Limited (2012-2015E) with yield sustainable above 5.5%. Lucy Liu Media business to solidify market leadership: We see BPL as a strategic (852) 2800-8566 asset which will enable NOW TV to consolidate its market value capture, i.e. a [email protected] 5% subs market share gain and a 31% increase in ARPU throughout the J.P. Morgan Securities (Asia Pacific) Limited upcoming three seasons. We are confident NOW TV can achieve much better James R. Sullivan, CFA monetization and profitability than i-Cable given: 1) its stronger pricing power (65) 6882-2374 (HK$288 for a BPL-bundled sports pack vs. i-Cable of base to absorb the fixed BPL costs. Our scenario analysis shows BPL can add Price Performance HK$0.3 to PCCW’s fair value. 4.4 IT solutions raising the profile (>20% yoy growth): PCCW Solutions is well 4.0 positioned to ride the rising demand for data center and cloud computing by HK$ leveraging its leadership in the local IT service industry, plentiful supply of 3.6 floor area to be converted to data centers and a fast increase in secure backlog 3.2 of cloud computing services. Acquisitions of value-accretive businesses that can Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 0008.HK share price (HK$) expand its core competencies and geographical reach are another growth driver. HSI (rebased) A free option of the growth businesses: PCCW is trading at a 24% discount to YTD 1m 3m 12m Abs -7.3% -8.6% -7.3% -7.3% the combined market value of its stakes in HKT and PCPD, in line with its Rel -8.4% -10.3% -17.0% -21.6% historical avg. This implies the improved growth prospects of its media and Solutions businesses are yet to be priced in. A re-rating is deserved, in our view. Initiate with OW on value recognition for growth businesses and attractive valuations at 12.6x 2014E P/E and 5.7x 2014E EV/EBITDA. PCCW’s commitment to a 70-80% pass-through of the cash distributions from HKT Trust (OW, covered by Lucy Liu) should be able to sustain a yield of > 5.5%. Our SOTP-based Dec-14 PT is HK$4.1. Downside risks include worse-than- expected BPL take-up, a sell-down of its stake in HKT and interest rate risk. PCCW Limited (Reuters: 0008.HK, Bloomberg: 8 HK) HK$ in mn, year-end Dec FY11A FY12A FY13E FY14E FY15E Company Data Revenue (HK$ mn) 24,638 25,318 28,132 30,180 32,390 52-week Range (HK$) 4.21-2.98 Revenue growth (%) 7.3% 2.8% 11.1% 7.3% 7.3% Market Cap (HK$ mn) 24,071 EBITDA (HK$ mn) 7,585 7,788 8,272 8,856 9,456 Market Cap ($ mn) 3,104 EBITDA Growth 3.2% 2.7% 6.2% 7.1% 6.8% Shares O/S (mn) 7,272 Net Profit (HK$ mn) 1,607 1,663 1,704 1,910 2,164 Free Float(%) 53.7% Net Profit growth (%) (16.6%) 3.5% 2.5% 12.1% 13.3% 3M - Avg daily volume (mn) 5.91 EPS (HK$) 0.22 0.23 0.23 0.26 0.30 3M - Avg daily value (HK$ 20.85 DPS (HK$) 0.16 0.19 0.19 0.20 0.20 mn) P/E (x) 15.0 14.5 14.1 12.6 11.1 3M - Avg daily value ($ mn) 2.7 EV/EBITDA (x) 5.6 5.9 5.8 5.7 5.5 HSI 2,2915.28 Dividend Yield 4.8% 5.8% 5.7% 5.9% 6.2% Exchange Rate 7.75 Source: Company data, Bloomberg, J.P. Morgan estimates. Price (HK$) 3.31 Date Of Price 13 Sep 13 See page 25 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan 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. www.jpmorganmarkets.com Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Company Description NAV sensitivity metrics PCCW is a Hong Kong-based company which (Impact on PCCW's end-2014E NAV holds interests in telecommunications (63% of HKT Trust), media (Now TV), IT solutions 10% change in HKT Trust's fair value 8.6% (PCCW Solutions), property development and 50bps increase in interest rate forecasts -2.5% to 2014E div. investment (74.5% of PCPD), and other businesses. Richard Li and China Unicom are the two largest shareholders with 28% and 18% interests in the company, respectively. Source: J.P. Morgan estimates. Price target and valuation analysis 2014E Revenue by business segment We use SOTP as the valuation methodology. We have arrived at our NAV estimate of HK$5.2 by combining the equity value of each business and Solutio Others adding the redemption value of its convertible bond issued to PCPD. Our ns , , 0.2% Dec-14 PT of HK$4.1 is based on a holding company discount of 20%. 12% Media, HKT, Risks to our price target 12% Downside risks include reduction of its stake in HKT Trust and interest rate 76% increase (lower dividend), slower-than-expected BPL take-up and yield de- rating in a rising interest rate environment. 2014E NAV by business segment Convertib Others le bond, , 4% 8% PCPD, HKT Net profit: J.P. Morgan vs consensus JPM Consensus 2% Trust, FY2013E 1,704 1,669 86% FY2014E 1,910 1,881 Source: Bloomberg and J.P. Morgan estimates HK Telco valuation comp table Op. FCF Ne t debt EBITDA CAGR EPS CAGR Company Stock Rating Price (HK$) PT % to EV /EBITDA P/E (x) Dividend yield P/B ROE yield /EBITDA code Index Level (HK$) Target 2013E 2014E 2013E 2014E 2013E 2014E 2014E 2014E 2014E 2014E (2012-2015E) (2012-2015E) HTHKH 215 HK OW 3.46 4.4 27% 5.9 5.3 13.0 12.3 5.7% 6.1% 1.4 11.5% 7.6% 1.0 7.0% 7.5% PCCW 8 HK OW 3.31 4.1 24% 5.8 5.7 14.1 12.6 5.7% 5.9% 2.6 20.9% 8.3% 3.0 6.7% 9.2% HKT Trust 6823 HK OW 7.06 8.1 15% 9.2 9.0 21.9 25.3 6.2% 6.4% 1.5 6.1% 6.1% 3.4 3.1% 6.4% Sm arTone 315 HK N 10.12 10.8 7% 5.5 5.3 12.4 12.4 6.5% 4.8% 3.3 27.7% 14.5% 0.2 1.0% -4.7% Hang Seng Index H S I n/a 22915 n/a n/a 7.4 6.6 10.9 10.1 3.5% 3.8% 1.2 17.9% n/a n/a n/a n/a Source: Bloomberg and J.P. Morgan estimates. Note: share prices and valuations are as of Sept 13, 2013. 2 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Table of Contents Investment Summary ...... 4 Valuations ...... 6 Investment positive 1: BPL a value-accretive strategic asset ...... 7 Pay TV leadership to strengthen ...... 7 Strong BPL monetization capability ...... 8 Profitability not a big concern...... 9 BPL worth HK$0.3/share ...... 10 Investment positives 2: IT Solutions riding the momentum ...... 11 Organic growth drivers...... 12 Expansion through acquisitions ...... 13 Investment positives 3: HKT a solid cash cow ...... 13 Investment concern 1: QE tapering – reduced appetite for yield plays ...... 14 Investment concern 2: Dividend vulnerable to interest rate risk...... 14 Financial analysis...... 16 SWOT...... 19 Appendix ...... 20 Historical financials ...... 20 Shareholding structure...... 21 Corporate Structure...... 21 Management profile ...... 21 Key milestones...... 22 3 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Investment Summary PCCW: Not just about telecom PCCW has a diversified businesses portfolio comprising: 1) the listed HKT Trust which is a strong-cash-generating integrated telecom operator in HK; 2) Pacific Century Premium Developments (PCPD) – a listed property firm with a current focus on resorts and office development in Asia; 3) NOW TV – the largest pay-TV service provider in HK; 4) IT Solutions – an enterprise IT service company mainly operating in HK and mainland China; 5) a still loss-making wireless broadband business in the UK; and 6) corporate support function (basically opex). Table 1: PCCW corporate structure – a combination of defensive telecom business and Figure 1: 2013E revenue breakdown growth businesses such as NOW TV and IT solutions. Solutions, PCPD, 2% Others, 10% 0.2% PCCW Limited Media, 11% 63.5% 74.5% 100% 100% Pacific Century HKT Trust Investments and Others Premium Developments Now TV IT Solutions (6823.HK) (incl. UK Broadband) HKT, 76% (432.HK) Telecom Growth businesses Source: J.P. Morgan estimates. Source: Company and J.P. Morgan research. PCCW separately listed HKT as a trust in Nov-11 aiming to unlock the value of the telecom assets by better aligning them with the investor base that favors stable dividend yields. Since the spin-off of HKT, the new stock has outperformed PCCW by 30%. At present, PCCW’s share price is trading at a 24% discount to the combined market value of its stakes in HKT and PCPD, slightly below its historical average of 23%. This implies the improved growth prospects of its media and Solutions businesses are yet to be priced in. Figure 2: PCCW’s share price has a close correlation with HKT’s, Figure 3: PCCW is trading at a 24% discount to the combined but it still has underperformed the latter by 30% since HKT's IPO. market value of its stakes in HKT and PCPD, slightly below its 200% historical average of 23%. 0% 180% -5% 160% -10% 140% -15% 120% Average discount = 23% -20% 100% -25% 80% 24% -30% 60% Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 PCCW HKT HSI index -35% Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Source: Bloomberg. Source: Bloomberg and J.P. Morgan estimates. 4 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] We attribute the underperformance of PCCW to three main reasons: Market was chasing yield names during 2011-2012. HKT was one of the largest beneficiaries due to its relatively high yield (7.5% back at IPO), stable cash generating capability and perception as a yield name given its trust structure. Non-listed portion was still in negative EBITDA as loss-making UK business, corporate function opex and internal eliminations more than offset the contributions from NOW TV and Solutions. Preference for pure telecom exposure. Time to appreciate the growth businesses, valuation gap to narrow NOW TV: the big gets bigger. The exclusive broadcasting of BPL starting from 2H13 is expected to drive strong subscriber market share gains and significantly increase ARPU. We believe NOW TV’s premium pricing power and its bundling/cross-selling capability should be able to achieve long-term value accretion through BPL, rather than just utilize it to enlarge the customer base at the expense of profitability. IT Solutions: an upgraded growth profile. We are expecting >20% yoy growth on both top-line and EBITDA in the coming years on the back of 1) its sizable secured order in the high-margin cloud computing business; 2) a plentiful supply of floor area to be converted to data centers to meet rising demand (high margin as well, utilization is expected to be high given its ‘build to demand’ strategy); and 3) expansion of service and geographical scope through acquisitions. PCCW deserves a re-rating. The fact that PCCW is trading at a discount in line with its historical average implies the market has yet to price in the better prospects of its growth businesses. Figure 4: We expect strong top-line growth in Solutions and NOW Figure 5: Unlisted portion is turning EBITDA positive this year. TV in the coming years. 1,500 25% 24% 23% 1,000 695 21% 383 556 20% 435 500 ) 17% n 631 585 m 491 499 D K H 15% ( - e u 14% n e (451) v (513) 12% e (583) R (842) 11% (500) (136) 10% (151) 8% (331) (1,000) (331) 5% 4% (1,500) 1% 2011 2012 2013E 2014E 0% Media business Solution business Other businesses Eliminations 2010 2011 2012 2013E 2014E Now TV Solutions Source: Company and J.P. Morgan estimates. Source: Company and J.P. Morgan estimates. 5 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Valuations We see NAV (Sum of the parts) as the most appropriate valuation methodology for PCCW given its multi-business portfolio. We have arrived at our NAV estimate of HK$5.2 by combining the equity value of each business and adding the redemption value of its convertible bond issued to PCPD. Our PT of HK$4.1 is based on a holding company discount of 20%. In the DCF analysis for the unlisted businesses, we assume a risk premium of 7.0% and a risk-free rate of 3%. We also estimate a beta of 0.9 and a terminal growth rate of 2% for its media business and 2.5% for its Solutions business, which results in a WACC of 8.3%. Table 2: SOTP valuation for PCCW SOTP analysis % of ownership (HK$m) (HK$/shr) Comments HKT Trust (6823.HK) 63% 32,745 4.5 Based on our Dec-14 PT of HK$8.1 for HKT PCPD (432.HK) 75% 652 0.1 Current market cap PCPD convertible bond 100.0% 2,920 0.4 Redemption value in 2014 Media, Solutions, UK wireless broadband, 100.0% 1,638 0.2 DCF as WACC of 8.3% corporate support function and eliminations of intra-group transactions Total 35,035 5.2 Holdco's discount 20% Historical avg. discount to the combined market value of its stakes in HKT and PCCW is 23% Value per share 4.1 Source: J.P. Morgan estimates. Figure 6: 2014E P/E vs EPS growth: PCCW’s valuations look Figure 7: 2014E EV/EBITDA vs gearing: PCCW’s valuations look attractive. attractive. 35x 14x SingTel 30x Bharti 12x Maxis HKT RCOM 25x Starhub TM 10x AIS APTT AXIATA Maxis M1 Digi HKT E M1 20x / A PLDT RCOM P D DTAC Starhub T TWM I E FET DTAC 8x CHT B 4 Softbank 1 E AXIATA Idea SingTel / 0 PLDT V 15x 2 EXCL AIS Telecom NZ E Globe Bharti SmarTone APTTTLKM Telstra E Telstra TM Docomo 4 6x 1 Softbank PCCW CT 0 HTHKH KDDI 2 10x CM TCOM NTT Telecom NZ HTHKH EXCL PCCW SKT SmarTone KT KDDI 5x 4x Indosat KT NTT SKT LGU+ CU 0x CT 2x -10% -5% 0% 5% 10% 15% 20% 25% 0x 1x 2x 3x 4x EPS CAGR 2012-2015E Net Debt/ EBITDA Source: Bloomberg and J.P. Morgan estimates. Note: CU is not shown in this chart. Source: Bloomberg and J.P. Morgan estimates. Note: Operators in a net cash position are not shown in this chart. Figure 8: P/E band Figure 9: EV/EBITDA band 70,000 8x 60,000 7x ) 50,000 6x n m 5.8x D K 5x H 40,000 ( V E 4x 30,000 J J J J J J J J J J 20,000 J J J J J J J J J J a u a u a u a u a u a u a u a u a u a u n l n l n l n l n l n l n l n l n l n l ------0 0 0 0 0 0 1 1 1 1 0 0 0 0 0 0 1 1 1 1 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 EV 4x 5x 6x 7x 8x Source: Bloomberg and J.P. Morgan estimates. Source: Bloomberg and J.P. Morgan estimates. 6 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Investment positive 1: BPL a value- accretive strategic asset PCCW’s NOW TV business has proved itself to be a true market leader with strong pricing power. It managed to deliver 3% subscriber market share gain and 3% ARPU increase over the past two years even without broadcasting BPL, which arguably is the most popular pay TV content in HK, while its major competitor i-Cable saw declines in both subscriber and ARPU despite being the BPL broadcaster. We believe the re-acquisition of the exclusive broadcasting rights of BPL should enable NOW TV to consolidate the market value capture, especially in the mid-to-high-end segment in the coming years. NOW TV is expected to achieve much better monetization and profitability on BPL than i-Cable through leveraging its larger base of customers, stronger pricing power, bundling with other sports content and cross- selling on PCCW’s quadruple platform. Our analysis suggests that BPL would be worth HK$0.3 to PCCW under the assumption that it will be able to hold the rights for the future years, which is very likely, in our view. Pay TV leadership to strengthen BPL drives subscriber flow We have seen a strong correlation between BPL and subscriber gain, especially during the first year after the ownership of the exclusive broadcasting rights shifts from one operator to the other; i.e. i-Cable to PCCW in 2007, and PCCW to i-Cable in 2010. We are projecting a 2%, 2% and 1% market share gain in 2013E- 2015E respectively, mainly at the expense of i-Cable whose loss of BPL broadcasting rights will likely cause high churn. Figure 10: Subscriber acquisition is typically particularly strong Figure 11: We expect PCCW's NOW TV to gain 5% market share during the first year after the ownership of the broadcasting rights throughout the three seasons. switches. 100% 160 PCCW won BPL in Nov-2006 33% 140 80% 39% 46% 46% 47% 46% 45% 47% 48% 50% 52% 53% 120 100 60% i-Cable won BPL ) 0 in Nov-09 0 80 0 ' ( s d d a 40% t e 60 N PCCW won 64% 53% 47% 46% 45% 46% 48% 45% 44% BPL in Nov-12 42% 40% 39% 40 20% 20 0 7% 7% 7% 8% 7% 7% 8% 8% 8% 8% 8% 0% 4% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E -20 PCCW i-Cable HKBN i-Cable PCCW Source: Company and J.P. Morgan estimates. Source: Company and J.P. Morgan estimates. 7 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Strong BPL monetization capability NOW TV charging high on BPL In the past, pay TV service providers have managed to increase their ARPUs significantly by charging additional for a BPL add-on. We believe this will be particularly true this time. NOW TV requires any new customer or any existing customer who is not using a sports pack yet to subscribe to a mandatory sports pack which costs HK$288. A standalone BPL add-on option is not provided this time. This reflects the strong pricing power and the diversified sports content NOW TV has that enable it to enforce such bundling. We are forecasting ARPU to jump from HK$174 in 1H13 to HK$209 in 2H13E then move up to HK$214 in 2014E driven by a continuous increase in BPL penetration. Table 3: BPL price comparison Monthly fee Now TV i-Cable New customers - a basic Pay TV package incl. BPL $428 $339 Existing customers- BPL add-on *Already a sports pack customer - $80 $50-80 *Not yet a sports pack customer -$288 for a super sports pack Source: Company and J.P. Morgan research. Figure 12: ARPU trend to diverge between PCCW NOW TV and i-Cable in the coming years 250 222 214 191 200 207 174 173 171 168 168 Now TV started BPL 159 in 2H13 Now TV started BPL 150 in 2H07 ) D 139 K H ( U 132 133 P R 126 124 120 A 114 100 88 107 110 i-Cable started BPL in 2H10 50 - 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E PCCW i-Cable Source: Company and J.P. Morgan estimates. A addressable existing customer base Besides gaining BPL fans from i-Cable, another important revenue source is to upgrade existing customers. This partly explains why we believe NOW TV is much better positioned than i-Cable to drive the internal upgrade based on two factors: 1) NOW TV has a diversified portfolio of popular sports content such as NBA, PGA Tour and Formula 1, etc. We believe NOW TV's existing sports program subscribers are likely to be more interested in BPL than i-Cable's customers are, given the latter’s main strength lies in its self-produced news and entertainment content. 8 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] 2) NOW TV has a customer base of higher profile, which is reflected in their higher average ARPU of HK$173 vs i-Cable of HK$133 in 2012. NOW TV’s customers’ willingness to spend more on pay TV service may indicate a higher likelihood of upgrade, in our view. Profitability not a big concern Margin hit is always a concern to BPL broadcasters in HK due to the high price of BPL broadcasting rights, i.e. i-Cable’s pay TV business was hardly break even during the last three seasons. However, we expect the EBITDA impact to NOW TV will be much lower than i-Cable based on several factors: Potentially more revenue contribution from BPL through higher charges and more internal upgrades, as discussed above. More operating leverage impact on the back of stronger top-line growth. NOW TV has a larger EBITDA base to absorb the cost in light of the fixed nature of BPL costs, rather than subscription-based. We estimate BPL content costs of HK$490mn a year for i-Cable relative to its pre-BPL EBITDA of HK$118mn in year 2009, which explained its struggle to break even during the last three seasons. However, NOW TV's pre-BPL EBITDA was already HK$491mn vs our estimated BPL costs of HK$470 mn per year for the next three seasons. Figure 13: We project margin to drop in 2H13/2014E before gradually trending up driven by operating leverage 30% 26% 27% 2013-2015: Fast revenuegrowth -> operating 25% 2011: Stopped broadcastingBPL leverage to drive margin (excl BPL costs) higher 23% 22% 20% 2011: Content 17% investment weighted 16% 15% on margin. 15% 15% 2013: Half 10% 10% year impact 2010: Half year impact of BPL of BPL 2014/2015: Full year impact of BPL 5% 0% 2010 2011 2012 2013E 2014E 2015E Now TV EBITDA margin Implied EBITDA margin (w/o BPL cost) Source: Company and J.P. Morgan estimates. 9 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] BPL worth HK$0.3/share We have done a scenario analysis to quantify the value of the exclusive broadcasting rights of BPL. The key assumptions in our analysis include: In a BPL scenario, we assume PCCW will hold the broadcasting rights from 2013 onwards. This is possible in light of i-Cable’s difficulty to even reach break- even with BPL over the past three years, thus we expect it to be less keen to obtain the content in the future compared to NOW TV. In the other so-called “Non-BPL Scenario”, we assume i-Cable will instead hold the broadcasting rights. We assume the broadcasting rights for BPL for three seasons costs USD1.8mn. We do not see a high likelihood of the costs to increase significantly in the foreseeable future in anticipation of more benign bidding in the future auctions. Subscriber growth in BPL scenario = 2x subscriber growth in the non-BPL scenario. ARPU: In the BPL scenario, we project ARPU to increase from HK$174 in 1H13 to HK$209 in 2H13E, then HK$214 in 2014E with an increase in BPL subs penetration. However, in the non-BPL scenario we are assuming a mild increase in ARPU every year. Margin in the BPL scenario is expected to bottom at 14.7% in 2014E with full year impact of the BPL, before following an upward trend driven by operating leverage and more revenue contribution from the high-margin distribution business. We are assuming a 50bps increase in margin each year for the non- BPL scenario. Table 4: BPL Scenario BPL senario 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Subscribers ('000) 1,140 1,183 1,254 1,308 1,355 1,395 1,433 1,469 1,501 1,532 1,560 1,586 1,612 net adds 101 43 71 54 47 40 38 36 33 31 28 26 26 ARPU (HKD) 168 173 191 214 222 228 234 238 241 244 246 248 249 yoy growth 0.2% 2.9% 10.4% 12.0% 4.0% 2.8% 2.2% 1.8% 1.4% 1.1% 0.9% 0.7% 0.6% Subscription revenue (HKD mn) 2,195 2,408 2,790 3,285 3,550 3,768 3,962 4,139 4,298 4,439 4,567 4,681 4,786 yoy growth 7.0% 9.7% 15.8% 17.7% 8.1% 6.1% 5.1% 4.5% 3.8% 3.3% 2.9% 2.5% 2.3% Other revenue (adversiting and channel distribution etc) 512 400 603 693 756 797 822 838 848 854 858 860 861 yoy growth 54.6% -21.8% 50.7% 15.0% 9.0% 5.4% 3.2% 1.9% 1.2% 0.7% 0.4% 0.3% 0.2% Total media revenue 2,707 2,808 3,393 3,978 4,306 4,565 4,784 4,977 5,146 5,293 5,425 5,541 5,648 yoy growth 13.6% 3.7% 20.8% 17.3% 8.2% 6.0% 4.8% 4.0% 3.4% 2.9% 2.5% 2.1% 1.9% EBITDA 631 491 499 585 676 762 823 881 937 990 1,042 1,092 1,141 Change of EBITDA compared to non-BPL scenario (21) 27 82 135 162 188 211 233 252 270 287 EBITDA margin 23.3% 17.5% 14.7% 14.7% 15.7% 16.7% 17.2% 17.7% 18.2% 18.7% 19.2% 19.7% 20.2% EBITDA margin excl. BPL content cost 23.3% 17.5% 21.6% 26.5% 26.6% 27.0% 27.0% 27.1% 27.3% 27.5% 27.8% 28.1% 28.5% Source: Company and J.P. Morgan estimates. 10 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Table 5: Non-BPL Scenario Non-BPL senario 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E Subscribers ('000) 1,140 1,183 1,219 1,246 1,269 1,289 1,308 1,326 1,342 1,357 1,372 1,385 1,398 net adds 101 43 36 27 23 20 19 18 16 15 14 13 13 ARPU (HKD) 168 173 175 177 179 181 182 183 183 184 185 186 187 yoy growth 0.2% 2.9% 1.5% 1.2% 1.0% 0.8% 0.6% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% Subscription revenue (HKD mn) 2,195 2,408 2,527 2,624 2,703 2,771 2,830 2,885 2,937 2,986 3,033 3,078 3,123 yoy growth Other revenue (adversiting and channel distribution etc) 512 400 412 428 440 450 458 465 470 475 478 481 483 yoy growth 54.6% -21.8% 3.0% 4.0% 2.8% 2.2% 1.8% 1.4% 1.1% 0.9% 0.7% 0.6% 0.5% Total media revenue 2,707 2,808 2,939 3,052 3,143 3,221 3,288 3,350 3,407 3,461 3,511 3,559 3,606 yoy growth 13.6% 3.7% 4.7% 3.9% 3.0% 2.5% 2.1% 1.9% 1.7% 1.6% 1.5% 1.4% 1.3% EBITDA 631 491 520 558 594 628 661 693 725 757 790 822 854 EBITDA margin 23.3% 17.5% 17.7% 18.3% 18.9% 19.5% 20.1% 20.7% 21.3% 21.9% 22.5% 23.1% 23.7% Source: Company and J.P. Morgan estimates. This exercise shows that BPL will be EBITDA accretive to the company starting 2014E and could potentially add HK$0.3 per share to the fair value of PCCW. Table 6: DCF analysis DCF analysis (HKD mn) 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E EBIT*(1-t) - BPL scenario 379 433 446 486 525 563 599 635 670 704 EBIT*(1-t) - Non-BPL scenario 388 402 384 407 430 453 477 500 523 547 D&A 159 172 183 191 199 206 212 217 222 226 Change in working capital ------Capital expediture (125) (131) (137) (144) (151) (159) (167) (175) (184) (193) Free cash flows 413 475 492 533 573 609 644 677 707 737 BPL Scenario Non-BPL Scenario NPV of cash flows 4,039 3,016 Perpetual growth 2.0% 1.0% PV of terminal value 5,856 3,914 Enterprise value 9,895 6,930 Equity value 9,895 6,930 Number of shares 7,272 7,272 Equity value/share (HKD) 1.4 1.0 Change 0.4 Holding company discount 20% Change to share value 0.3 Source: J.P. Morgan estimates. Note: For simplicity we assume change in working capital and net cash equal zero, thus HK$1.4 above does not represent the true fair value of Now TV. This analysis is aimed at showing the change in fair value due to BPL. Investment positive 2: IT Solutions riding the momentum We started to see stronger growth momentum in Solutions business starting in 2H12, benefiting from the increase in demand for IT services, incl. cloud and data center hosting services. We believe as a leading player in the market PCCW is well positioned to ride the cloud computing and data center growth trends, and these businesses should provide margin lift as well. We are expecting >20% yoy growth on both top-line and EBITDA in the coming years on the back of 1) its sizable secured order in the high-margin cloud computing business; 2) a plentiful supply of floor area to be converted to data centers to meet the rising demand; and 3) expansion of service and geographical scope through acquisitions. 11 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Figure 14: Accelerating revenue growth Figure 15: Margin trending up gradually 5,000 30% 1,000 20.0% 18.4% 18.1% 18.3% 18.0% 17.6% 25% 17.3% 24% 24% 4,000 23% 800 16.0% 20% 13.9% 14.0% ) ) n 3,000 n 600 12.0% m h 15% m D h t 11.3% t K D w K H w o ( 10.5% r o H ( r e 12% g 10.0% g u y A y n 11% o 9.1% D o e 10% Y Y v T I e 2,000 8.4% 9% B 400 8.0% R 8% E 5% 5% 6.0% 4% 1,000 200 4.0% 0% 3.0% -1% 2.0% - -5% 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E - 0.0% 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E Revenue yoy growth EBITDA margin Source: Company and J.P. Morgan estimates. Source: Company and J.P. Morgan estimates. Table 7: Two types of IT services offered by PCCW Solutions Solutions Operations Design, build and integrate systems for enterprise applications Maintain and operate application systems, managed services and data center hosing Project-based Service-based Typically large scale and high value contractgs Typically long term and recurring engagements Typically lower margin than a recurring contract Typically higher margin than a project contract 30% of total revenue 70% of total revenue Source: Company and J.P. Morgan estimates. Organic growth drivers With its reputation as one of the leading IT service providers in HK and mainland China, PCCW is well positioned to capture growth opportunities in several IT service areas, which we think will be able to support double-digit organic growth on the top- line in the coming years. Cloud computing Secured backlog of cloud computing services has significantly increased from USD18mn in 1H12 (3% of total secured order) to USD64mn in 1H13 (10% of total secured order). This supports a transition to a more recurring-based model ->higher margin. Data center PCCW Solutions is a leading player in HK’s data center hosting market. A 'build to demand' strategy’ ensures that the new builds can translate to the top- line quickly. Growth backed by plentiful supply of secured floor area: A 202,000 sq. ft. facility in Kwai Chung is expected to open in phases from the fourth quarter of this year, for which PCCW Solutions has already secured a number of long-term contracts. Total data center space would increase to about 423,000 sq. ft. by the end of 2013. In 1H13, the company has further secured another 36,000 sq.ft. to cater for the increasing pipeline. 12 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Expansion through acquisitions PCCW Solutions is also actively seeking acquisition targets to expand its product and geographical scope. The company is adopting a prudent approach to select targets which are required to meet criteria including: Financially accretive to PCCW A well-run company in its own right Competency closely aligned with PCCW's existing business Smooth integration into PCCW, etc. PCCW acquired Vanda China, a core banking software provider in mainland China, in 2H12 and Compass Solutions, a leading service provider of SAP’s Enterprise Resource Planning solutions, in 1H13. Both companies are strong players in their fields and complement well PCCW's offerings in the banking and financial sector as well as its expertise in Oracle ERP. The two companies combined are estimated to contribute US$20-30mn revenue this year in our estimates. Investment positives 3: HKT a solid cash cow The strong cash-generating capability of HKT provides PCCW with steady dividend income through its 63% ownership of HKT. We forecast a low-to-mid-single-digit increase in HKT’s distributions in the coming years. With its new guidance of passing 70%-80% of the cash it receives from HKT to its own shareholders, PCCW is expected to better align its investors with the favorable cash distributions from HKT. We are forecasting a gradual increase in the pass-through ratio from 78% in 2013E to 80% in 2015E on the back of strong FCF positions of its NOW TV and Solutions businesses, which implies a dividend yield of 5.7% to 6.2% for 2013E-2015E. Figure 16: Steady growth of cash distributions from HKT Figure 17: Sustainable yield above 5.7% 3,500 80% 8.0% 78% 79% 80% 72% 3,000 T K H 599 m 60% o r 607 f 2,500 616 d e v 745 i 6.6% e c e r 6.4% 2,000 n h s m 6.2% 6.2% a c $ 40% f K o H 5.9% o 1,500 i 6.0% t a 5.7% r h 2,285 2,395 g 2,183 u 1,000 o 1,927 r 20% h t - s s a 500 P - 0% 2012 2013E 2014E 2015E Cash from HKT to be distributed to PCCW's shareholders 4.0% Cash from HKT to be retained within corporate 2013E 2014E 2015E Pass-through ratio HKT PCCW Source: Company and J.P. Morgan estimates. Note: Pass-through ratio = cash to be Source: Company and J.P. Morgan estimates. distributed to PCCW’s shareholders/ total cash received from HKT. 13 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Investment concern 1: QE tapering – reduced appetite for yield plays HK telcos are generally considered high yield names. We expect them to deliver an average yield of 5.8% in 2014E, vs the average Asian telco yield of 4.4%. However, the high-yield characteristics, along with the high correlation between HK sovereign yields and the US yield (see below) exposes the sector to a greater level of risk when market appetite for yield plays subsides as Fed QE tapering talk lifts U.S. bond yields. Focus on fundamentals, not just yields We believe yield plays with solid fundamentals will be better off in a rising sovereign yield environment as investors will likely shift more attention to company fundamentals from yields. Figure 18: 2014E dividend yield: Hong Kong telcos offers 5.8% vs Figure 19: HK and US 10yr govt. bond yield, 2000-NOW regional telco average of 4.4%. 8.0% 7.0% 7.0% 6.4% 6.2% 6.4% 6.0% 5.8% 5.0% 4.8% 4.5% 4.1% 4.0% 3.5% 3.5% 3.0% 2.5% 2.0% 1.0% 0.5% 0.0% Source: Bloomberg. India Japan Indonesia China Korea Malaysia Singapore Hong Kong Thailand Philippine ANZ Taiwan Source: Bloomberg and J.P. Morgan estimates. Investment concern 2: Dividend vulnerable to interest rate risk PCCW’s relatively high gearing at 2.8x net debt/EBITDA, with the majority of debt borne on HKT, exposes the company to meaningful interest rate risk in a rising yield environment. Our sensitivity analysis shows that a 50bps increase in the interest rate would reduce PCCW’s cash receipt from HKT by 2.5% and 3.0% in 2014E and 2015E respectively. Refinancing risk will emerge in 2015E when a US$500mn bond with a 5.25% coupon rate expires. 14 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Figure 20: Debt profile of PCCW/HKT Figure 21: Sensitivity analysis of interest rate change impact on PCCW’s cash distributions 2014E 2015E 2016E 50bps -2.5% -3.0% -3.8% 100bps -4.9% -5.9% -7.5% Source: J.P. Morgan estimates. Note: Assume interest rate change to floating rate borrowings only. Source: Company. 15 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Financial analysis Income statement We expect PCCW’s core revenue to increase by 13.6% in 2013 and then by high- single-digit growth rate in 2014E/2015E. Now TV and PCCW Solutions are projected to be the major revenue drivers. Margin is expected to slip by 1.4pp to 29.4% in 2013E due to margin dilution from HKT’s recently-acquired gateway business and additional BPL costs. We expect net income to increase by a marginal 2.5% in 2013E, before jumping to 12.1% yoy in 2014E thanks to a slow-down in D&A growth of HKT . Table 8: P&L HK$ mn 2011 2012 2013E 2014E 2015E Revenue HKT 19,825 21,081 23,072 24,185 25,224 TSS 17,295 18,366 20,042 20,821 21,614 Mobile 1,967 2,466 2,887 3,289 3,590 Media business 2,707 2,808 3,393 3,978 4,306 Solutions business 2,209 2,477 3,052 3,775 4,688 Other businesses 74 71 63 64 66 Eliminates (2,303) (2,303) (2,160) (2,273) (2,366) Core Revenue 22,512 24,134 27,420 29,730 31,916 yoy growth 4.9% 7.2% 13.6% 8.4% 7.4% PCPD 2,126 1,184 712 451 473 Total 24,638 25,318 28,132 30,180 32,390 Cost of sales (11,397) (11,816) (13,830) (15,023) (16,304) Operating costs (ex D&A) (5,656) (5,714) (6,030) (6,302) (6,630) EBITDA 7,585 7,788 8,272 8,856 9,456 yoy growth 3.2% 2.7% 6.2% 7.1% 6.8% EBITDA margin 30.8% 30.8% 29.4% 29.3% 29.2% yoy growth -1.2% 0.0% -1.4% -0.1% -0.1% Core EBITDA 7,252 7,681 8,236 8,833 9,432 yoy growth 3.2% 2.7% 6.2% 7.1% 6.8% Core EBITDA margin 32.2% 31.8% 30.0% 29.7% 29.6% yoy growth -0.7% -0.4% -1.8% -0.3% -0.2% HKT 7,411 7,669 7,846 8,142 8,404 margin 37.4% 36.4% 34.0% 33.7% 33.3% Media business 631 491 499 585 676 margin 23.3% 17.5% 14.7% 14.7% 15.7% Solution business 383 435 556 695 867 margin 17.3% 17.6% 18.2% 18.4% 18.5% Other business (842) (583) (513) (451) (397) Eliminations (331) (331) (151) (136) (118) PCPD 333 107 36 23 24 D&A (3,949) (4,421) (4,671) (4,790) (4,843) EBIT 3,636 3,367 3,600 4,066 4,613 yoy growth 2.3% -7.4% 6.9% 12.9% 13.5% EBIT margin 14.8% 13.3% 12.8% 13.5% 14.2% yoy growth -0.7% -1.5% -0.5% 0.7% 0.8% (Loss)/gain on disposal of PP&E 1 (13) - - - Net other gains 143 371 350 250 200 Interest income 71 62 57 109 110 Finance costs (1,565) (966) (1,056) (1,258) (1,291) Share of results of associates 44 31 28 25 23 Share of results of jointly controlled companies (12) (53) 40 50 60 Profit before tax 2,318 2,799 3,019 3,242 3,715 Income tax (542) (232) (242) (357) (520) Tax rate 23.4% 8.3% 8.0% 11.0% 14.0% Minority interests (169) (904) (1,074) (976) (1,031) Net income attributable to unitholders 1,607 1,663 1,704 1,910 2,164 yoy growth -16.6% 3.5% 2.5% 12.1% 13.3% Net income margin 6.5% 6.6% 6.1% 6.3% 6.7% Source: Company and J.P. Morgan estimates. 16 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Balance sheet We are forecasting a high net debt/ EBITDA ratio around 2.8x for 2013E-2015E, with the majority of debt borne by HKT. Table 9: Balance sheet HK$ mn 2011 2012 2013E 2014E 2015E Properties for sale 455 214 214 214 214 Sales proceeds held in stakeholders’ accounts 632 678 678 678 678 Restricted cash 735 1,319 1,319 1,319 1,319 Prepayments, deposits and other current assets 3,497 4,775 5,491 6,205 7,012 Inventories 1,166 1,084 1,056 1,034 1,009 Amounts due from related companies - 93 - - - Derivative financial instruments - 4 - - - Trade receivables, net 3,084 4,041 4,925 5,479 5,913 Tax recoverable 7 13 13 13 13 Cash and cash equivalents 5,365 4,553 8,737 8,773 5,118 Current assets 14,941 16,774 22,434 23,716 21,276 Property, plant and equipment 15,477 15,534 15,668 15,814 16,101 Investment properties 5,384 5,804 6,094 6,399 6,719 Interests in leasehold land 530 512 492 472 452 Properties held for/under development 1,105 1,146 1,146 1,146 1,146 Goodwill 3,170 3,371 3,371 3,371 3,371 Intangible assets 2,812 3,385 3,672 3,865 3,965 Interests in associates 402 591 768 922 1,106 Interests in jointly controlled companies 515 539 604 604 604 Held-to-maturity investments 2 1 1 1 1 Available-for-sale financial assets 575 685 822 986 1,184 Derivative financial instruments 275 253 253 253 253 Deferred income tax assets 148 703 1,216 1,670 2,079 Other non-current assets 514 546 601 661 727 Non-current assets 30,909 33,070 34,709 36,165 37,707 Short-term borrowings 40 8,540 109 7,136 9,519 Trade payables 1,777 2,380 2,618 2,880 3,168 Accruals and other payables 4,134 4,129 4,129 4,129 4,129 Amount payable to the gvt. 603 959 959 959 959 Carrier licence fee liabilities 187 196 206 216 226 Amounts due to related companies 27 136 136 136 136 Advances from customers 1,750 1,903 1,998 2,098 2,203 Current income tax liabilities 786 1,169 1,169 1,169 1,169 Dividend payable 1,443 - - - - Current liabilities 10,747 19,412 11,324 18,723 21,508 Long-term borrowings 23,470 17,926 32,917 27,812 23,468 Derivative financial instruments - 56 56 56 56 Deferred income tax liabilities 2,222 2,321 2,321 2,321 2,321 Deferred income 893 989 1,088 1,197 1,316 Defined benefit liability 3 3 3 3 3 Carrier licence fee liabilities 815 719 619 519 419 Other long-term liabilities 120 101 101 101 101 Non-Current liabilities 27,523 22,115 37,105 32,009 27,684 Share capital 1,818 1,818 1,818 1,818 1,818 Reserves 4,286 7,161 6,485 5,944 5,555 Non-controlling interests 1,476 (662) 412 1,387 2,418 Total equity 7,580 8,317 8,714 9,149 9,791 Source: Company and J.P. Morgan estimates. Cash flow statement We project capex of HK$2.6bn, HK$2.6bn and HK$2.7bn for 2013E, 2014E, 2015E, respectively, implying a decreasing capex/sales ratio of 9.1%, 8.6% and 8.4%. We forecast the company will gradually increase the pass-through rate of HKT cash distributions from 78% in 2013E to 80% in 2015E, which implies 2-3% growth in DPS per year. 17 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Table 10: Cash flow statement HK$ mn 2011 2012 2013E 2014E 2015E Operating activities Profit before income tax 2,318 2,799 3,019 3,242 3,715 Adjustment for: Impairment loss for doubtful debts 169 186 - - - Provision for inventory obsolescence 10 7 - - - Interest income (71) (62) (57) (109) (110) Interest expense 1,315 825 920 1,122 1,155 Finance charges 245 136 136 136 136 Cash flow hedges: transferred from equity 1 1 - - - Fair value gains on derivative financial instruments on fair value hedges (198) (31) - - - Fair value adjustment of borrowings attributable to interest rate risk 202 35 - - - Depreciation of property, plant and equipment 2,549 2,482 2,435 2,459 2,418 Net gain from return of investment of available-for-sale financial assets - (3) - - - Net gains on cash flow hedging instruments transferred from equity (39) (13) - - - Fair value gains on investment properties (25) (349) - - - Impairment loss on an interest in a jointly controlled company 16 - - - - Assets and business received from the JV (644) - - - - (Gain)/loss on disposal of property, plant and equipment and intangible assets, net (1) 13 - - - Amortization of intangible assets 1,378 1,917 2,215 2,309 2,403 Amortization of land lease premium – interests in leasehold land 22 22 22 22 22 Share of results of associates and jointly controlled companies (32) 22 - - - Increase in treasury stock for the purchase of PCCW Shares under share award schemes - (26) - - - Decrease in equity for the purchase of Share Stapled Units under Share Stapled Units award schemes - (5) - - - Decrease in non-controlling interests for the purchase of Share Stapled Units under Share Stapled Units award schemes - (2) - - - Share-based compensation expenses - 17 - - - Change in working capitals (213) (1,529) (2,149) (1,818) (1,752) Decrease/(Increase) in operating assets – properties held for/under development/for sale 259 170 - - - – inventories (190) 75 28 22 25 – trade receivables (724) (240) (884) (554) (434) – prepayments, deposits and other current assets (294) (1,144) (712) (714) (807) – sales proceeds held in stakeholders’ accounts 213 (46) - - - – restricted cash 1,546 (616) - - - – amounts due from related companies 2 (75) 93 - - – other non-current assets (49) (32) (1,015) (952) (959) Increase/(Decrease) in operating liabilities – trade payables, accruals and other payables and deferred income 182 (211) 248 272 298 – amount payable to the Government under the Cyberport Project Agreement (1,003) 356 - - - – amounts due to related companies (39) 109 - - - – other long-term liabilities (6) (20) (1) 9 20 – advances from customers (110) 145 95 100 105 Cash generated from operations 7,002 6,442 6,541 7,363 7,986 Interest received 77 49 57 109 110 Income tax paid, net of tax refund Hong Kong profit tax paid (241) (265) (184) (299) (462) Overseas profits tax paid (60) (58) (58) (58) (58) Net cash generated from operating activities 6,778 6,168 6,356 7,116 7,576 Investing activities Proceeds from disposals of property, plant and equipment 23 9 - - - Proceeds from return of investments of available-for-sale financial assets 31 10 - - - Proceeds from repayment of held-to-maturity investments - 1 - - - Net outflow of cash and cash equivalents in respect of additions upon business combinations - (220) - - - Settlement of obligation assumed upon business combinations - (121) (65) - - Acquisition of associates (56) - - - - Acquisition of jointly controlled companies (7) - - - - Capital contribution to associates (28) (29) - - - Capital contribution to a jointly controlled company - (4) - - - Loan to an associate (71) (139) - - - Loan to a jointly controlled company (41) (71) - - - Purchases of available-for-sale financial assets (229) (129) (137) (164) (197) Purchases of property, plant and equipment (1,960) (2,236) (2,569) (2,605) (2,705) Payment for investment properties (27) (19) - - - Purchases of intangible assets (1,902) (2,524) (2,524) (2,524) (2,524) Interest received 154 - - - - Dividend received from associates 40 12 - - - Consideration paid to acquire non-controlling interests of subsidiaries - (1,559) - - - Net cash generated from investing activities (4,073) (7,019) (5,295) (5,293) (5,426) Financing activities Proceeds from dilution of interest in the HKT Group 9,302 - - - - Listing expenses paid (360) (167) - - - Finance fees paid for new borrowings raised - (111) - - - New borrowings raised 6,251 6,747 10,433 1,922 5,000 Interest paid (1,528) (840) (1,056) (1,258) (1,291) Repayments of borrowings (17,975) (3,884) (3,873) - (6,962) Dividends paid to shareholders of the Company (1,127) (1,172) (1,370) (1,418) (1,486) Dividends paid to non-controlling shareholders of subsidiaries (35) (595) (1,010) (1,032) (1,067) Decrease/(Increase) in restricted cash - 32 - - - Decrease/(Increase) in contribution from non-controlling interests of a subsidiary - 30 - - - Net cash generated from financing activities (5,472) 40 3,123 (1,786) (5,805) Change in cash and cash equivalents (2,767) (811) 4,184 36 (3,655) Exchange differences 31 (1) - - - Beginning of year 8,101 5,365 4,553 8,737 8,773 End of year 5,365 4,553 8,737 8,773 5,118 Source: Company and J.P. Morgan estimates. 18 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Table 11: J.P. Morgan forecasts vs consensus. 2013E 2014E 2015E Sales (HK$ mn) Consensus 26,968 28,085 29,092 J.P . M organ 28,132 30,180 32,390 Difference 4.3% 7.5% 11. 3% EBITDA (HK$ mn) Consensus 8,205 8,570 8,961 J.P . M organ 8,272 8,856 9,456 Difference 0.8% 3.3% 5.5% EBITDA margin (%) Consensus 30.4% 30.5% 30.8% J.P . M organ 29.4% 29.3% 29.2% Difference -1.0% -1.2% -1.6% Net profit (HK$ mn) Consensus 1, 669 1, 881 2,14 5 J.P . M organ 1, 704 1, 910 2,16 4 Difference 2.1% 1. 5% 0.9% DPS (HK$ ) Consensus 0.18 0.19 0.21 J.P . M organ 0.19 0.20 0.20 Difference 3.1% 0.7% -4.0% Source: Bloomberg and J.P. Morgan estimates. SWOT Table 12: SWOT analysis Strengths Weaknesses * Leading pay TV service provider with a competitive content portfolio * Vulnerable to interest rate risk due to high gearing * Leading IT solutions service provider, i.e. one of the biggest data center player in HK * Strong pricing power in various businesses, i.e. broadband and pay TV Opportunities Threats * Bundling/ cross selling opportunity on its quadruple platform * Intensifying pricing competition in broadband and mobile market. * Expansion of the solutions business through potential acquisitions * Leverage market leadership to catch the rising demand for data centre and cloud computing services Source: J.P. Morgan. 19 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Appendix Historical financials Table 13: Summary of interim financials HK$ mn 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13E Revenue 14,124 11,513 11,607 12,108 11,372 20,579 12,774 12,303 11,802 11,160 12,186 12,452 11,906 13,412 13,314 14,818 HKT n/a n/a n/a n/a n/a n/a n/a n/a 9,206 9,321 9,537 10,288 9,715 11,366 11,071 12,001 TSS 7,405 7,969 7,706 8,930 8,551 8,914 8,241 8,051 8,071 8,152 8,259 9,036 8,425 9,941 9,630 10,412 Mobile 585 651 668 800 857 887 828 842 838 871 919 1,048 1,133 1,333 1,360 1,527 Media business 303 436 715 988 1,039 1,200 1,092 1,258 1,179 1,204 1,189 1,518 1,262 1,546 1,299 2,094 Solutions business 737 915 826 969 900 966 905 939 1,058 981 1,090 1,119 1,128 1,349 1,393 1,659 Other businesses 364 227 165 84 43 43 26 35 13 27 35 39 38 33 28 35 Eliminates (546) (672) (573) (697) (636) (756) (624) (738) (724) (798) (915) (1,388) (1,085) (1,218) (976) (1,184) Core Revenue 8,848 9,526 9,507 11,074 10,754 11,254 10,468 10,387 10,732 10,735 10,936 11,576 11,058 13,076 12,815 14,605 yoy growth 7.4% 16.3% 13.1% 1.6% -2.7% -7.7% 2.5% 3.4% 1.9% 7.8% 1.1% 13.0% 15.9% 11.7% PCPD 5,276 1,987 2,100 1,034 618 9,325 2,306 1,916 1,070 425 1,250 876 848 336 499 213 Revenue growth HKT n/a n/a n/a n/a n/a n/a n/a n/a 4% 10% 2% 10% 14% 6% Media business 136% 127% 45% 21% 5% 5% 8% -4% 1% 26% 6% 2% 3% 35% Solutions business 12% 6% 9% 0% 1% -3% 17% 4% 3% 14% 3% 21% 23% 23% Other businesses -55% -63% -74% -49% -40% -19% -50% -23% 169% 44% 9% -15% -26% 6% Core Revenue 7% 16% 13% 2% -3% -8% 3% 3% 2% 8% 1% 13% 16% 12% Cost of sales (7,555) (5,131) (5,199) (5,339) (4,942) (12,908) (6,431) (5,823) (5,484) (5,049) (5,499) (5,898) (5,281) (6,535) (6,343) (7,487) Operating costs (2,917) (3,207) (2,799) (3,082) (2,994) (3,125) (2,753) (2,571) (2,596) (2,480) (2,912) (2,744) (2,789) (2,925) (3,025) (3,005) EBITDA 3,650 3,174 3,609 3,687 3,436 4,546 3,590 3,909 3,722 3,631 3,775 3,810 3,836 3,952 3,946 4,326 margin 25.8% 27.6% 31.1% 30.5% 30.2% 22.1% 28.1% 31.8% 31.5% 32.5% 31.0% 30.6% 32.2% 29.5% 29.6% 29.2% Core EBITDA 2,942 2,926 3,068 3,438 3,364 3,350 3,284 3,434 3,369 3,700 3,535 3,717 3,670 4,011 3,936 4,300 yoy growth 4.3% 17.5% 9.6% -2.6% -2.4% 2.5% 2.6% 7.7% 4.9% 0.5% 3.8% 7.9% 7.2% 7.2% margin 33.3% 30.7% 32.3% 31.0% 31.3% 29.8% 31.4% 33.1% 31.4% 34.5% 32.3% 32.1% 33.2% 30.7% 30.7% 29.4% yoy growth -1.0% 0.3% -1.0% -1.3% 0.1% 3.3% 0.0% 1.4% 0.9% -2.4% 0.9% -1.4% -2.5% -1.2% HKT n/a n/a n/a n/a n/a n/a n/a n/a 3,523 3,726 3,623 3,788 3,736 3,933 3,839 4,007 margin n/a n/a n/a n/a n/a n/a n/a n/a 38.3% 40.0% 38.0% 36.8% 38.5% 34.6% 34.7% 33.4% Media business (186) (150) (74) (83) (40) (43) (34) 38 43 189 231 400 217 274 223 276 margin -61.4% -34.4% -10.3% -8.4% -3.8% -3.6% -3.1% 3.0% 3.6% 15.7% 19.4% 26.4% 17.2% 17.7% 17.2% 13.2% Solution business 83 68 102 48 82 113 82 127 139 145 157 226 168 267 217 339 margin 11.3% 7.4% 12.3% 5.0% 9.1% 11.7% 9.1% 13.5% 13.1% 14.8% 14.4% 20.2% 14.9% 19.8% 15.6% 20.4% Other business (297) (464) (335) (587) (335) (761) (315) (495) (336) (360) (476) (366) (312) (271) (268) (245) Eliminations (2) (1) ------(331) (139) (192) (75) (76) D&A (1,467) (1,569) (1,610) (1,660) (1,750) (1,946) (1,889) (1,891) (1,883) (1,917) (1,962) (1,987) (2,134) (2,287) (2,266) (2,405) EBIT 2,183 1,605 1,999 2,027 1,686 2,600 1,701 2,018 1,839 1,714 1,813 1,823 1,702 1,665 1,680 1,920 margin 24.7% 16.8% 21.0% 18.3% 15.7% 23.1% 16.2% 19.4% 17.1% 16.0% 16.6% 15.7% 15.4% 12.7% 13.1% 13.1% 25% 20% (Loss)/gain on disposal of PP&E (2) (34) 9 (9) - (122) - (61) (2) (43) 1 - (3) (10) 5 (5) Net other gains 98 (62) 55 (58) 16 (651) (12) 255 33 1,181 99 44 12 359 196 154 Interest income 312 420 236 193 74 123 12 6 9 18 33 38 27 35 37 20 Finance costs (928) (1,080) (846) (812) (664) (809) (748) (737) (806) (781) (763) (802) (469) (497) (595) (461) Share of results of associates and JV 18 19 (1) 14 (7) (13) (31) (23) (13) (69) (8) 40 (43) 21 32 36 Profit before tax 1,681 868 1,452 1,355 1,105 1,128 922 1,458 1,060 2,020 1,175 1,143 1,226 1,573 1,355 1,664 Income tax (609) (311) (377) (593) (417) (294) (174) (411) (207) (549) (292) (250) 51 (283) 90 (332) Tax rate 36.2% 35.8% 26.0% 43.8% 37.7% 26.1% 18.9% 28.2% 19.5% 27.2% 24.9% 21.9% -4.2% 18.0% -6.6% 19.9% Minority interests 278 (658) (253) (81) (32) (218) (94) (195) (88) (310) (59) (110) (441) (463) (589) (485) Net income to unitholders 1,350 (101) 822 681 656 616 654 852 765 1,161 824 783 836 827 856 848 yoy growth -39.1% n/a -20.2% -9.5% -0.3% 38.3% 17.0% 36.3% 7.7% -32.6% 1.5% 5.6% 2.4% 2.6% Source: Company and J.P. Morgan estimates. 20 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Shareholding structure Figure 22: Shareholder structure China United Network Richard Li and Pacif ic Communications Group Others Century Group Company Limited (Unicom) 28% 18% 54% PCCW Limited Source: Company and Bloomberg. Corporate Structure Figure 23: Corporate Structure PCCW Limited 63% 75% 100% 100% Pacific Century HKT Trust Investments and Others Premium Developments Now TV IT Solutions (incl. UK Broadband) (6823.HK) (432.HK) Source: Bloomberg, company and J.P. Morgan estimates. Management profile Table 14: Management profile Name Title Description Richard Li Executive Chairman & Executive Director Executive Chairman & Executive Director of PCCW since 1999, and he also holds senior position in HKT Trust and PCPD, both PCCW's subsidiaries. He has a 28% interest in PCCW as of 2012 mainly through his investment firm Pacific Century Group. George Chan Executive Director & Group Managing Director Executive Director & Group Managing Director of PCCW since 2011. Has more than 30 years of experience in the media and technology industries. Susanna Hui Group Chief Financial Officer Group Chief Financial Officer since 2007 and Executive Director since 2010. Source: Company and J.P. Morgan research 21 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Key milestones Table 15: Key milestones Year 2000 Acquired Cable & Wireless HKT, including subsidiary CSL, from Cable & Wireless Entered into a strategic alliance with Legend Holdings Ltd. to increase broadband access across China Signed a project agreement for the development of Cyberport Entered into a strategic broadband content distribution agreement with Japan's Tomen Mediacom Started trading on the NYSE Acquired a majority stake in Jaleco Ltd, later renamed Pacific Century CyberWorks Japan K.K. Acquired 37.65% stake in ChinaBig Entered into an alliance with Telstra and formed 3 companies: Reach (an IP backbone company), a regional wireless Acquired 100% of Hutchison Telecommunications Technology Investments group 2001 Associate iLink Holdings Limited Reach entered into an agreement to acquire the Asian assets of US based broadband infrastructure company, Level 3 Communications Inc Sold 60% of CSL to Telstra in a joint venture called "Regional Wireless Company" (RWC) 2002 Signed an agreement with Sinopec to form the PCITC alliance to provide IT services in China Sold remaining 40% stake in RWC to Telstra Formed a wholly-owned subsidiary Cascade, a technical services company 2003 China Unicom acquired a 20% interest in PCCW and became the 2nd largest shareholder Entered into a data-carrying deal with China Telecom Launched pay-TV service, NowTV Launched the Unihub brand for the IT business in China and HK Signed an agreement with China Mobile to provide a management information system Launched PCCW Convergence for business executives 2004 Announced an agreement to transfer its investment properties, the Cyberport development project and related property and facilities management operations to Dong Fang Gas Holdings Partnered with Shanghai Telecom to offer a premium business data-carrying service between HK and Shanghai Transferred its property related assets and operations to Pacific Century Premium Developments (PCPD) 2005 Entered into a strategic alliance with China Netcom Group to develop business in China and internationally Entered into a strategic alliance with AsiaWorld-Expo Management Limited to provide ICT services Returned to mobile business by acquiring SUNDAY and creating a new brand 'PCCW Mobile' Cascade entered into a contract with True Corp, for an IPTV project Launched PCCW Global to expand international business Sold 12.1% of MobileOne Ltd. 2006 Cascade announced installation of an end-to-end IPTV system PCCW Global and China Telecom Group announced the first International Ethernet Private Line service to provide high-bandwidth connectivity between HK and China 2007 PCCW Global partnered with Bharti Airtel to extend connectivity to India PCCW Global and China Netcom unveiled the 1st high-end International Ethernet Private Line (IEPL) service between HK and Beijing Launched NETVIGATOR Everywhere PCCW Global and Telecom NZ International signed an agreement on IP-network connection Launched eye Multimedia Services and wireless broadband solution 'NETVIGATOR Everywhere' 2008 PCCW Global signed an agreement to interconnect with du HK Government launched its public Wi-Fi service, powered by PCCW Reorganised the Group's telecom services, media and IT solutions businesses into a new company called HKT Group Holdings Limited PCCW delivered 3G network deployment based on CDMA2000 technology 2009 Launched PCCW eye2 PCCW Global launched the TGN-Intra Asia Cable System Launched NETVIGATOR Pocket Wi-Fi, a mobile broadband service Acquired 70% stake in two companies operating contact centers in Philippines, USA and Panama Partnered with Hutchison Telecommunications to operate within the 2500-2600Mhz spectrum band for 4G data services 2010 PCCW Solutions launched cloud computing services for enterprises Launched MOOV on now TV 2011 PCCW spun off HKT for a separate listing on the Hong Kong stock exchange Now TV and HaiRun Media & Entertainment Group Limited formed a JV company to launch a new channel Now TV and Hunan Broadcasting System partnered to launch a new channel Completed a restructuring of Reach through direct ownership of certain infrastructure assets of the latter Launched a cloud-based multimedia storage device - uHub 2012 HKT launched 4G network PCCW Solutions introduced Eneterprise Solutions Superstore Alliance, a cloud platform PCCW Solutions acquired Vanda China, a banking software vendor Now TV signed a content distribution deal with Telekom Malaysia Now TV entered into an agreement with Cable Thai Holding Public Company Limited to distribute 3 channels on the latter's pay tv platform Now TV won exclusive broadcasting rights of EPL for season 2013/14-2015/16 2013 Launched LTE CAT 4 Started to broadcast EPL season 2013/14 in Aug Source: Company and J.P. Morgan research. 22 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] JPM Q-Profile PCCW Limited (HONG KONG / Telecommunication Services) As Of: 13-Sep-2013 [email protected] Local Share Price Current: 3.32 12 Mth Forward EPS Current: 0.26 120.00 2.00 100.00 1.50 80.00 1.00 60.00 0.50 40.00 0.00 20.00 -0.50 0.00 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 -1.00 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / / / / l l t t 0 1 7 8 r r r r r 8 9 9 0 2 2 3 3 4 5 5 6 6 7 9 9 0 0 1 2 2 3 y c v y c v g b p n n g b p n n g c u c u 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 a p a p a a e o a e o u e e u a u e e u a u / / / / / / / / / / / / / / / / / / / / / / / / / / J J l l t t r r r r r O A O A J J J J y c v y c v M F M F M g b p n n g b p n n g A D S N A D S N A M M c u c u a p a p a a e o a e o u e e u a u e e u a u J J O A O A J J J J A M D F S N A M D F S N A M M M Earnings Yield (& local bond Yield) Current: 8% Implied Value Of Growth* Current: -21.89% 16% 12Mth fwd EY Hong Kong BY Proxy 1.50 14% 12% 1.00 10% 8% 0.50 6% 0.00 4% 2% -0.50 0% -2% -1.00 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 / / / / / / / / / / / / / / / / / / / / / / / / / / l l t t r r r r r 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 y c v y c v g b p n n g b p n n g / / / / / / / / / / / / / / / / / / / / / / / / / / c u c u a p a p a l l t t a e e o u a a e e o u a r r r r r u e u e u y c v y c v J J g b p n n g b p n n g c u c u O A J J O A J J a p a p a M F M F M A D S N A D S N A a e o a e o u e e u a u e e u a u M M J J O A O A J J J J M F M F M A D S N A D S N A M M PE (1Yr Forward) Current: 13.0x Price/Book Value Current: 2.8x 70.0x 2500.0x PBV hist PBV Forward 60.0x 2000.0x 50.0x 40.0x 1500.0x 30.0x 20.0x 1000.0x 10.0x 0.0x 500.0x -10.0x 0.0x -20.0x -30.0x -500.0x 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / / / / 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 l l t t / / / / / / / / / / / / / / / / / / / / / / / / / / r r r r r g y c b p v n n g y c b p v n n g l l t t r r r r r c u c u y c v y c v g b p n n g b p n n g a p a p a a e o a e o u e e u a u e e u a u c u c u a p a p a J J a e o a e o u e e u a u e e u a u O A O A J J J J J J M F M F M A D S N A D S N A O A O A M M J J J J M F M F M A D S N A D S N A M M ROE (Trailing) Current: 19.74 Dividend Yield (Trailing) Current: 5.70 350.00 9.0 300.00 8.0 250.00 7.0 200.00 6.0 150.00 5.0 100.00 4.0 50.00 3.0 0.00 2.0 -50.00 1.0 -100.00 0.0 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 8 9 9 0 0 1 2 2 3 3 4 5 5 6 6 7 7 8 9 9 0 0 1 2 2 3 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / l l t t r r r r r l l y c v y c v r t r r t r r g b p n n g b p n n g y c v y c v g b p n n g b p n n g c u c u a p a p a u u c c a e o a e o a p a p a u e e u a u e e u a u a e o a e o J J u e e u a u e e u a u J J O A O A J J J J M F M F M O A O A A D S N A D S N A J J J J M M A M D F S N A M D F S N A M M M Summary PCCW Limited 3160.26 As Of: 13-Sep-13 HONG KONG 2.937385 SEDOL 6574071 Local Price: 3.32 Telecommunication Services Diversified Telecommunication Services EPS: 0.26 Latest Min Max Median Average 2 S.D.+ 2 S.D. - % to Min % to Max % to Med % to Avg 12mth Forward PE 12.97x -20.00 60.43 12.92 11.88 29.62 -5.86 -254% 366% 0% -8% P/BV (Trailing) 2.82x -9.46 145.16 2.70 13.40 73.94 -47.14 -436% 5048% -4% 375% Dividend Yield (Trailing) 5.70 0.00 8.07 3.28 2.54 7.53 -2.44 -100% 42% -42% -55% ROE (Trailing) 19.74 -43.01 290.01 6.05 51.70 200.55 -97.16 -318% 1369% -69% 162% Implied Value of Growth -21.9% -0.78 1.06 0.22 0.13 0.88 -0.63 -256% 586% 202% 158% Source: Bloomberg, Reuters Global Fundamentals, IBES CONSENSUS, J.P. Morgan Calcs * Implied Value Of Growth = (1 - EY/Cost of equity) where cost of equity =Bond Yield + 5.0% (ERP) 23 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] PCCW Limited: Summary of Financials Income Statement Balance sheet HK$ in millions, year end Dec FY11 FY12 FY13E FY14E FY15E HK$ in millions, year end Dec FY11 FY12 FY13E FY14E FY15E Revenue 24,638 25,318 28,132 30,180 32,390 Cash and cash equivalents 5,365 4,553 8,737 8,773 5,118 EBITDA 7,585 7,788 8,272 8,856 9,456 Accounts receivable 3,084 4,041 4,925 5,479 5,913 Depreciation (2,549) (2,482) (2,457) (2,481) (2,440) Others 5,326 7,092 7,715 8,429 9,236 Amortization (1,400) (1,939) (2,215) (2,309) (2,403) Total current assets 14,941 16,774 22,434 23,716 21,276 EBIT 3,636 3,367 3,600 4,066 4,613 Interest income 71 62 57 109 110 ST loans 40 8,540 109 7,136 9,519 Interest expense (1,565) (966) (1,056) (1,258) (1,291) Others 8,930 8,492 8,597 8,707 8,822 Associates - - - - - Total current liabilities 10,747 19,412 11,324 18,723 21,508 Profit before tax 2,318 2,799 3,019 3,242 3,715 Tax (542) (232) (242) (357) (520) Net working capital 4,194 (2,638) 11,110 4,993 (232) Net profit - reported 1,607 1,663 1,704 1,910 2,164 Net fixed assets 15,477 15,534 15,668 15,814 16,101 Shares Outstanding (mn) 7,272 7,263 7,263 7,263 7,263 Other long term assets 7,681 8,711 9,549 10,348 11,122 EPS (HK$) (reported) 0.22 0.23 0.23 0.26 0.30 Total non-current assets 30,909 33,070 34,709 36,165 37,707 DPS (HK$) 0.16 0.19 0.19 0.20 0.20 DPS payout ratio 72.0% 83.2% 80.4% 74.3% 68.7% Total Assets 45,850 49,844 57,143 59,881 58,983 Revenue growth 7.3% 2.8% 11.1% 7.3% 7.3% Long-term debt 23,470 17,926 32,917 27,812 23,468 EBITDA growth 3.2% 2.7% 6.2% 7.1% 6.8% Other liabilities 938 879 779 679 579 Net profit growth (16.6%) 3.5% 2.5% 12.1% 13.3% Total Liabilities 38,270 41,527 48,429 50,731 49,192 DPS growth 3.9% 19.9% (1.0%) 3.5% 4.7% Shareholders' equity 7,580 8,317 8,714 9,149 9,791 Total liabilities and equity 45,850 49,844 57,143 59,881 58,983 Net debt/(cash) 18,145 21,913 24,289 26,174 27,868 Book value per share 0.84 1.24 1.14 1.07 1.02 Ratio Analysis Cash flow statement %, year end Dec FY11 FY12 FY13E FY14E FY15E HK$ in millions, year end Dec FY11 FY12 FY13E FY14E FY15E EBITDA margin 30.8% 30.8% 29.4% 29.3% 29.2% Cash flow from operations 6,778 6,168 6,356 7,116 7,576 FCF margin 24.3% 18.8% 16.7% 18.3% 18.2% Capex (1,960) (2,236) (2,569) (2,605) (2,705) Cash flow from other investing (2,073) (3,233) (2,726) (2,688) (2,721) ROE 113.1% 22.1% 19.7% 23.8% 28.6% Cash flow from financing (5,472) 40 3,123 (1,786) (5,805) ROC 9.1% 9.5% 8.6% 8.6% 9.6% ROA 3.4% 3.5% 3.2% 3.3% 3.6% Change in cash for year (2,736) (812) 4,184 36 (3,655) Tax rate 23.4% 8.3% 8.0% 11.0% 14.0% Beginning cash 8,101 5,365 4,553 8,737 8,773 Capex to sales 8.0% 8.8% 9.1% 8.6% 8.4% Closing cash 5,365 4,553 8,737 8,773 5,118 Debt/Capital 79.4% 74.7% 79.9% 81.8% 81.7% Net debt or (cash) to equity 239.4% 263.5% 278.7% 286.1% 284.6% Interest coverage (x) 5.1 8.6 8.3 7.7 8.0 Source: Company reports and J.P. Morgan estimates. 24 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Other Companies Recommended in This Report (all prices in this report as of market close on 13 September 2013) HKT Trust and HKT Limited (6823.HK/HK$7.06/Overweight) Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. Important Disclosures Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for HKT Trust and HKT Limited within the past 12 months. Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: PCCW Limited, HKT Trust and HKT Limited. Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as investment banking clients: HKT Trust and HKT Limited. Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation from investment banking HKT Trust and HKT Limited. Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from HKT Trust and HKT Limited. Company-Specific Disclosures: Important disclosures, including price charts, are available for compendium reports and all J.P. Morgan– covered companies by visiting https://mm.jpmorgan.com/disclosures/company, calling 1-800-477-0406, or e-mailing [email protected] with your request. J.P. Morgan’s Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477-0406 or e-mail [email protected]. PCCW Limited (0008.HK, 8 HK) Price Chart 9 8 7 N HK$2.1 6 Date Rating Share Price Price Target N HK$5 N HK$5.1N HK$5.1 N HK$5.1 N (HK$) (HK$) 5 30-Nov-06 N 5.05 5.00 Price(HK$) 4 06-Mar-08 N 4.55 5.10 25-Aug-08 N 4.83 5.10 3 23-May-09 N 2.29 5.10 2 25-Aug-09 N 2.05 2.10 20-Apr-10 N 2.28 -- 1 0 Oct Apr Oct Apr Oct 06 08 09 11 12 Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends. Initiated coverage Nov 30, 2006. 25 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] HKT Trust and HKT Limited (6823.HK, 6823 HK) Price Chart 15 14 13 12 OW HK$9.3 11 10 OW HK$6.8 OW HK$8.25 9 8 Date Rating Share Price Price Target Price(HK$) 7 (HK$) (HK$) 6 03-Jul-12 OW 6.18 6.80 5 27-Feb-13 OW 7.10 8.25 4 17-May-13 OW 8.24 9.30 3 2 1 0 Nov Feb May Aug Nov Feb May Aug 11 12 12 12 12 13 13 13 Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends. Initiated coverage Jul 03, 2012. The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings or designations: OW = Overweight, N= Neutral, UW = Underweight, NR = Not Rated Explanation of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-Australia) and U.K. small- and mid-cap equity research, each stock’s expected total return is compared to the expected total return of a benchmark country market index, not to those analysts’ coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analyst’s coverage universe can be found on J.P. Morgan’s research website, www.jpmorganmarkets.com. J.P. Morgan Equity Research Ratings Distribution, as of June 28, 2013 Overweight Neutral Underweight (buy) (hold) (sell) J.P. Morgan Global Equity Research Coverage 44% 44% 12% IB clients* 56% 50% 40% JPMS Equity Research Coverage 42% 50% 8% IB clients* 76% 66% 55% *Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category. 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