6 July 2016 EQUITIES Hong Kong Telcos WIRELESS TELECOMS Upgrade PCCW to Buy: spotlight on media growth Hong Kong Deep dive into Media business: like the prospects of OTT and Neale Anderson* free-to-air; confident Now TV can withstand new competition Head of Telecoms Research, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited [email protected] Cut HKT forecasts on higher tax, cut DCF valuation, downgrade +852 2996 6716 to Hold: like option on media growth at PCCW Aric Hui* Analyst The Hongkong and Shanghai Banking Corporation Limited Raise PCCW’s TP by 21% and upgrade to Buy (from Hold) on [email protected] +852 2822 3165 revised valuation of the Media business *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is We like the market position and growth prospects of PCCW Media. We have not registered/ qualified pursuant to FINRA regulations done a deep dive into the Viu Over The Top (OTT) business and believe its focus on Asian (particularly Korean) media means it is clearly differentiated from its peers (iflix, Hooq, and Netflix). It had attracted more than 9m users, in more than 10 markets, by March 2016, and we expect rapid revenue growth to become a key share price driver for PCCW (TP: HKD6.30). The ViuTV Free To Air (FTA) channel was launched in April and has been well received by both audiences and advertisers. Earlier in 2016, we were worried that the Now TV business was at risk from the growth of OTT content in Hong Kong. However, it has moved swiftly to shore up its position with new content, and we expect it can successfully defend its existing subscriber base. We expect PCCW to benefit from economies of scale and scope as it pools staff and resources to develop content for these different business lines. Raise PCCW’s valuation on Media business, trim HKT on higher tax forecast. We now value each media business separately based on peer multiples, and we triple our total Media valuation, from HKD2bn to HKD6.3bn. For HKT (TP: HKD12.50), we raise our tax estimate, which we now believe was too low, reducing our DCF valuation by 5%. We expect continued benefits from mobile cost reductions, but limited re-pricing benefits in either mobile or residential broadband. Our PCCW forecasts are below consensus on profits, but we expect the market to look to the strong subscriber and revenue momentum in the new business. We expect the OTT business to move to EBITDA break-even in 2018. With continued pass-through of a growing HKT dividend, PCCW shareholders can be paid while the media growth story unfolds. We believe our 3x price-to-sales multiple for the OTT business is conservative. In our bull case scenario, ✔ Vote in Asiamoney Brokers Poll 2016 applying a 5x price-to-sales multiple results in a valuation per PCCW share of HKD6.50 4 July - 12 August If you value our service and insight, vote for HSBC – with OTT comprising 10% of the total – compared with 6% in our base case. Click here to vote Hong Kong Telcos: key data Stock code Company Old TP New TP Change Old New 5-Jul price Upside Mkt cap Daily vol EV/EBITDA PE Div yield HKD HKD rating rating HKD USDm USDm FY16e FY16e FY16e 8 HK PCCW 5.20 6.30 21.2% Hold Buy 5.22 21% 5,007 5 5.7 14.5 4.2% 6823 HK HKT Trust 13.20 12.50 -5.3% Buy Hold 11.30 11% 10,925 12 9.5 19.0 4.9% Source: Company data, Bloomberg, HSBC estimates Disclosures & Disclaimer Issuer of report: The Hongkong and Shanghai This report must be read with the disclosures and the analyst certifications in Banking Corporation Limited the Disclosure appendix, and with the Disclaimer, which forms part of it. View HSBC Global Research at: https://www.research.hsbc.com EQUITIES WIRELESS TELECOMS 6 July 2016 Contents Investment summary 3 Media valuation 6 Over The Top: growth engine 10 Free-to-Air 16 Now TV 19 PCCW (8 HK) 23 HKT (6823 HK) 28 Appendix 33 Disclosure appendix 39 Disclaimer 43 2 EQUITIES WIRELESS TELECOMS 6 July 2016 Investment summary Analysis of PCCW Media and its competitors leads to substantial change in view: believe content and market positioning is strong Continue to see steady growth at HKT, but organic growth muted by strong competition in mobile and residential broadband Revised Media valuation underpins 21% increase in PCCW SOTP valuation: upgrade to Buy; downgrade HKT to Hold on higher taxes Media business – well-positioned Following greater segment disclosure in the PCCW Annual Report we now value each component of the Media business separately. These are the core ‘Now TV’ pay-tv business, and the free-to-air ViuTV business (launched in April 2016) – both of which are primarily operating in Hong Kong. The Viu business is an ‘Over The Top’ (OTT) app and web-based platform, which delivers Asian content using a ‘freemium’ model: free access is supported by advertising revenue, while premium services and access is available to customers paying a subscription. Key costs are content, translation and dubbing. Viu: the ‘Over The Top’ business has strong growth momentum. Viu reached over 9m subscribers in more than 10 markets by March 2016. We believe it is clearly differentiated in terms of content, region and business model from its competitors – chiefly iflix and Hooq. We model EBITDA break-even in 2018, with negative EBITDA in the Media business weighing on our forecasts relative to consensus in 2016-18e. ViuTV Free to Air business: a market opportunity. Following the demise of ATV in April 2016, ViuTV has a clear market opportunity. Its fresh approach has been well-received, and we expect it to take a 20% share of TV advertising net spend in Hong Kong by 2020. Media revenue to double by 2020e EBITDA contribution starts in 4 years 7,000 700 Now TV Viu ViuTV Now TV 600 6,000 Viu 500 400 ViuTV 5,000 300 200 4,000 100 0 3,000 -100 -200 2,000 -300 Dec-14 Dec-16 Dec-18 Dec-20 Dec-14 Dec-16 Dec-18 Dec-20 Source: Company data, HSBC estimates Source: Company data, HSBC estimates 3 EQUITIES WIRELESS TELECOMS 6 July 2016 Core ‘Now TV’ business remains solid. Our concern at the start of the year over OTT growth in Hong Kong (see our report of 8 January 2016, Game of Phones) has diminished as Now TV has expanded its content line-up and secured sports rights deals. We expect it to maintain its market share, with substitution by OTT only likely in certain niche markets. We model low single-digit growth in revenue, and a flat EBITDA margin at 16%. These businesses share can share content, studio and human resources, enabling relatively low operating costs for a diverse business. This means PCCW can leverage its deals with the Korean studios across multiple platforms. Solutions business – stable We make no changes to our solutions business forecast in this report. This remains a difficult business to forecast, with a high degree of variability as a result of new contracts. We believe our forecasts are conservative: we assume a 2015-17 revenue CAGR of 5% (compared with 10% CAGR in 2013-15) and a 2015-17e EBITDA CAGR of 6% (compared with 15% between 2013 and 2015). PCCW notes that the business is relatively defensive, with corporate clients looking to save costs via outsourcing and solutions in a difficult economic environment. In June 2016 PCCW Solutions launched the D-Infinitum Global Data Centre Alliance, covering 80 data centre facilities across 40 cities globally. We believe this should broaden the appeal of PCCW’s services, and look for more details at half-year results in early August. HKT business – stable, but growth harder to come by We continue to like the outlook for HKT Trust, which we expect to derive further cost savings as it integrates the CSL mobile business. We make no changes to our revenue and profit forecasts in this report, but after speaking to the different entities in Hong Kong we expect the organic growth outlook in mobile and residential broadband to remain muted. In mobile competition (particularly at the low end) remains tough, while in residential broadband HKBN (1310 HK – HKD8.20 – Buy – TP HKD12.50) has increased its subscriber growth target from 60,000 to 100,000 for FY ending August 2016 and 2017. The sole adjustment we make is to our cash tax estimate, which we now believe was too low, and did not correctly reflect the using up of tax offsets accrued via the acquisition of CSL. This drives a reduction in our cash flow forecast, and thus the 5% reduction in our target price. Hong Kong Telcos ___________ HSBCe vs consensus _____________ __________ HSBCe vs prior estimates ___________ FY15e FY16e FY17e 2015e 2016e 2017e PCCW PCCW Sales 0.2% 0.7% -0.2% Sales 1.6% 3.1% 4.3% EBITDA -2.7% -5.2% -5.9% EBITDA -0.6% -1.5% 0.4% OP -2.4% -5.0% 0.3% OP -1.3% -3.1% 0.3% Net income 5.8% -1.6% 16.8% Net income -2.4% -5.9% 0.5% EPS 6.8% 0.0% 15.8% EPS -2.4% -5.9% 0.5% HKT Trust HKT Trust Sales 1.2% 1.4% 0.7% Sales 0.0% 0.0% 0.0% EBITDA -0.5% -2.0% -4.3% EBITDA 0.0% 0.0% 0.0% OP 2.3% -2.4% -9.0% OP 0.0% 0.0% 0.0% Net income 4.3% 0.1% -6.2% Net income 0.0% 0.2% 0.4% EPS 4.1% -0.5% -6.8% EPS 0.0% 0.2% 0.4% Source: Company data, Bloomberg, HSBC estimates 4 EQUITIES WIRELESS TELECOMS 6 July 2016 Forecasts vs consensus, prior estimates Our forecasts vs consensus and vs our prior estimates are outlined in the table below: PCCW.